Interest Rates and Your Financial Future

Blog post #462

Interest rates have been quite low for over a decade and are not likely to increase in the next few years. This has important implications for all investors.

The 10-year US Treasury bond yield has been below 4% since 2008, in the 2-3% range for most of 2009-2019, and has been well below 1% since the Covid pandemic hit in March of this year. (see the chart below).

The Federal Reserve on Wednesday provided forward guidance that they project short-term interest rates to remain near zero well into 2023. Eventually they predict short-term rates of around 2.5%, but they do not provide any guidance as to when that may occur. While their forward guidance (projections) have generally not been accurate, they are basing these predictions on the impact of Covid on the economy and the lack of current and expected future inflation.

What is the impact of continued low interest rates mean to you?

When we do investment planning for you, one of the most important decisions is how much to allocate to stocks and how much to allocate to fixed income (bonds, CDs, bond mutual funds, cash, etc.).

This high level asset allocation decision is based on several factors, which include your need and willingness to take risk, how much growth you need from your investments to meet your financial goals and your investment timeframe.

As we review these items with you, that will guide our recommendation of how much of your portfolio should be in stocks and how much should be in fixed income.

The key concept that we want to stress is that even though interest rates are very low, and may remain that way for a while, this should not significantly change how much you should allocate to fixed income. 

Why? Shouldn’t the prospect of continued lower interest rates make someone want to increase their stock allocation, as the fixed income returns will be very low? Let’s look at some examples and discuss this further.

If you are in your 20s or 30s and have decades of work and savings ahead of you, we may recommend a stock allocation of 80% or even more.

If you are in your 40s or 50s and need growth from your portfolio to provide for the retirement you desire, your asset allocation may be 60-70% in stocks, with the remainder in fixed income.

If you are in your 70s or 80s and have saved enough so that you can live comfortably, your stock allocation may be well below 50%.

We don’t think the prospect of continued very low interest rates should materially change your overall asset allocation plan because most people don’t want to significantly increase their stock market risk more than they need to.

If you feel that because of expected continued low interest rates you should decrease your fixed income allocation and increase your stock exposure, you must be prepared for the increased volatility (short term risk) that comes with owning more stocks.

Fixed income provides you with some income, but we view the fixed income allocation primarily to provide stability to your portfolio. Thus, you don’t have as much temporary volatility that comes with owning stocks. If you have the stomach to own more stocks, and can handle the swings and volatility, then your expected returns could be much greater over the long-term, say 10 or more years. But for most investors, they need the ballast of fixed income in their portfolio.

As we remind clients, it is normal for stock markets to decline at least 20-30% every 3-5 years. That is the type of temporary volatility that is to be expected in order to earn the long-term rewards of owning stocks.

  • If someone had a $2 million portfolio with a 50% stock / 50% fixed income portfolio, they would have $1 million invested in stocks. If that portfolio incurs a 35% decline, as happened in the S&P 500 earlier this year, the stocks would decline by $350,000.
  • But if the stock allocation had been increased to 75% because of lower expected interest rates on the fixed income allocation, they would have had $1.5 million invested in stocks. If a 35% stock market decline occurred, the temporary decline would be $525,000, which is far greater than the $350,000 temporary drop of a 50/50 portfolio.

The question you must ask yourself: Is the additional volatility of the stock market worth the increased exposure to stocks? Will you be able to maintain a higher stock market exposure through the down periods? This is so important, because the worst result would be to increase your stock market exposure now, then panic when a major stock market decline occurs.

We plan to remain consistent with our long-term principles regarding fixed income.

  • We will only invest in high quality fixed income, as the return of your principal is most important.
  • We will not reach for yield by buying junk bonds. If a bond fund says high yield, that means it is holding less than investment grade securities, which have a much greater chance of defaulting. We don’t recommend junk or high yield bond funds for our clients.
  • Diversification is vital in fixed income. For those who invest in municipal bonds, we recommend holding bonds of many states, not just your home state.
  • We regularly monitor your fixed income holdings of corporate and municipal bonds for any downgrades or credit risk exposure. We would rather sell today than take the chance on a default in the future.

The financial world is continuously changing. We are here for you, if you have any questions about this or other financial matter. 

We would be pleased to assist you, your family members and friends.

Source:

 

 

Thoughts on Where We are Now and Headed

Blog post #441

As we near the end of April 2020, we thought it would make sense to step back and consider the past few months, as well as approaches for the future.

  • As we have stated many times in the past, one of the basic concepts that we have told our clients is that we do not have a crystal ball and we cannot predict the future. No one can accurately predict the future, repeatedly and successfully.
  • This is why we work with you as a fundamental building block to develop a personalized asset allocation strategy developed for your personal circumstances and needs.
    • Throughout this crisis, and many others that have preceded it, having an Investment Policy Statement (IPS), or asset allocation plan, has enabled clients to remain invested and in the long term, be able to continue and reach their financial goals.
    • We can’t control or predict the financial markets. But we can control your plan and how you are invested, to meet your short-term withdrawal needs and your long-term financial goals and objectives.
      • Thus, we recommend continuing to adhere to the strategy of maintaining your personal Investment Policy Statement (IPS), or asset allocation, especially in this very unpredictable period.
  • Despite a decline in your account value, which you could view as temporary, a key question to ask is: has this decline directly impacted your ability to have the financial resources that you need today, or within the next year?
    • While none of us are happy that account values have declined, the answer for all of our clients should be that they have the financial resources that they need for the short to intermediate term, for the next number of years. This positive answer is due to proper planning.
  • The stock market is not the economy.
    • Remember, the stock market tends to look into the future and may not reflect what the economy is doing right now. The stock market can be driven by many factors, such as cash flow and profit/loss projections, predictions and emotions.
  • Fed Chair Powell has done a terrific job so far.
    • The Federal Reserve has been strong, responsive and acted swiftly when needed, especially in March and early April. This is one of the key reasons that the stock market has recovered significantly from its March lows.
    • The Fed’s actions have helped to solidify the fixed income markets and has enabled many public companies to sell bonds during this crisis, to help them to have the liquidity to get through the shutdown period. The Fed’s decisions to purchase bonds of companies that were credit worthy prior to this crisis, and then expanded to less than investment grade debt, has also helped to stabilize the credit markets.
  • Diversification works, for both stocks and fixed income
    • We are strong believers in diversification at all levels, as are the mutual funds that we use to invest in.
      • The past few months has not changed our minds about this. If anything, during a crisis, diversification again has proven to be very important. 
    • While our client accounts have been volatile, there has not been the huge destruction of your investments compared to if we held a portfolio that had been concentrated in certain sectors, say for example…..lodging and travel, aerospace, airlines, retail, entertainment and energy. We have not had overall 40%-50%-60% declines, though these sectors are held as part of a diversified portfolios.
    • We don’t place bets on individual stocks or focus on sectors. The asset class funds that we use strongly believe in diversification and have guidelines across industries and companies, as well as geographic regions, for International and Emerging Market funds.
    • While we still believe in our core investment beliefs, that does not mean that we don’t make changes. We have modified our portfolios over past months, prior to and during this crisis, to reduce some exposure to small value holdings in both the US and internationally. We did this for the long term, as we wanted to increase exposure to small cap asset classes that were not strictly small value.
      • In the short term, this has been a positive move. Again, this was made to increase diversification further and should benefit clients over the long term, as we cannot predict which asset class will outperform, or when.
    • In fixed income, we have always been well diversified, and we are taking steps to strengthen your holdings, and add even greater diversification.
      • Due to the economic impact of the Covid crisis and the plunge in oil prices, certain companies that previously were investment grade or not at risk of near-term bankruptcy, are now potentially more at risk.
      • We have been proactive in selling bonds of companies that were previously much stronger financially. We would rather sell these bonds now, prior to their maturities, and not put your investment principal at further risk with these types of companies.
      • We are reviewing clients’ fixed income holdings very carefully, as we always have, for exposures to sector and financial risk.
      • We are using large and well-established bond funds with excellent track records, processes and methodologies, more than we did in the past, so your fixed income holdings will be even more diversified.
      • We will be more carefully monitoring the impact of this crisis on municipal bonds, as state and local revenues have been impacted. We already know that some of the strict purchasing guidelines we have in place, and have had since we started our firm, are still valid today, and have helped us avoid municipal bonds which are related to single sector issuances, like airport or certain single source building projects.
      • We want the fixed income “Foundation” of your portfolio to be as financially sound as it can be, even during this period of greater financial uncertainty.
  • Expect the unexpected
    • This certainly has been the case over the past few months. However, even with all this uncertainly, and there could be more in the future, we want you to have a sense of financial comfort.
  • We will continue to act and make rational decisions, not emotional ones. We are not going to place bets on when a vaccine will be discovered or how fast the economy will recover…..as no one knows those answers. We do know that sticking to a philosophy works, over the long-term. We will continue to do the following:
    • Regularly review and rebalance your accounts.
    • Place tax loss trades as appropriate, which will save you tax dollars.
    • Adhere to your financial asset allocation plan and modify that if your circumstances have changed.
    • Having a strong fixed income foundation and ample cash and liquid assets for those regularly withdrawing money.
  • We have again been reminded why we avoid certain types of investments.
    • We don’t invest in investment funds or products that are considered illiquid or restrict your right to redeem your money to a certain percentage a quarter or annually.
      • Many of these types of investments are not permitting withdrawals or severely restricting investors’ access to their money. We don’t want your money to be restricted, so we don’t use these types of products.
    • We don’t invest in high yield or junk bonds, as they have the greatest risk of default, and many of them declined significantly in value during past months. The higher interest rate that they offer are not worth it, if you don’t get your principal back.
    • We don’t invest in stocks primarily due to high dividend yield, as those companies tend to be the riskiest, like junk bonds. This does not apply to all companies, but those paying a very high dividend yield is often a sign of some type of underlying risk in the company. And usually the risk is not worth it, especially if the dividend is later cut or eliminated, or the price of the stock eventually declines significantly. This is what has occurred to many energy stocks. While the funds we utilize hold energy stocks, the exposure is quite small.
      • Bottom line….don’t reach for yield…..if the interest or dividend yield is far above the market average, there is usually a good reason…it is much more risky.

 

As always, we are here for you, and family members or friends who could use our guidance and assistance during this crisis.

Three Cuts and They’re Out-For Now

Blog post #418

The US Federal Reserve cut short term interest rates on Wednesday, for the third time since July, 2019. They signaled that this is likely to be the last reduction for now, unless the economy slows sharply.

“The current stance of (interest rate) policy is likely to remain appropriate” as long as the economy expands moderately and the labor market remains strong, said Fed Chairman Jerome Powell in a press conference after the Fed’s two day meeting.*

This rate cut reduces the federal funds range by .25%, to a range between 1.50%-1.75%. This impacts short term interest rates, but long term interest rates have also declined in 2019.

Analysts interpreted the Fed’s statement and press conference answers to indicate that the bar has been raised for the next increase or decrease, meaning it is likely that short term rates will remain at these levels for a number of quarters into the future.

Major change since last year

These actions are in sharp contrast to the Fed’s actions in 2018, when they raised short term interest rates 4 times, and had expectations for further increases well into 2019 and 2020.

A year ago, the Fed funds range was 2-2.25% and were expected to be in range of 2.75%-3.25% by the end of 2019, as our blog post dated November 8, 2018 discussed.

Due to weakening global growth, continued trade-policy uncertainty and muted inflation, the Fed felt it was necessary to cut rates during 2019. Current short term interest rates are 1%-1.5% less than the Federal Reserve expected at this time last year. This shows how difficult it is to predict the direction of interest rates and financial markets.

Longer term interest rates have also dropped significantly over the past year. The 10 year US Treasury Note yield was 3.214% at the end of October, 2018 (last year). Today, that rate is 1.70%, a drop of more than 1.5%. This has had the impact of reducing mortgage rates and other borrowing costs during the past year.

How is the economy doing?

We remain positive about the economy and growth in the US. Throughout 2019, many analysts and financial commentators have expressed recession concerns in the US and globally. There is still no sign of that occurring now.

Economic data continues to show that companies and US consumers are doing well. US GDP, an indication of economic growth, grew at an annual rate of 1.9% in the last quarter. This was stronger than economists expected, but less than than the growth in the prior quarter of 2.0%. Business spending did decline, but consumer spending remains strong, as does housing and unemployment remains at 50 year lows.**

Corporate earnings continue to beat analysts expectations. While overall earnings for the S&P 500 are on track to decline for the 3rd straight quarter, about 75% of the 342 companies that have reported earnings as of the morning of October 30th have beaten Wall Street expectations. The energy sector accounts for most of the reason for the decline in corporate profits, and along with utilities, have the most earnings misses.***

Based on this information, if the energy sector was excluded, it appears that corporate profits continue to grow. The growth in corporate earnings, and their future expectations, is what causes stock prices to increase in the long run. Earnings are expected to grow 5.7% and 7.1%, respectively, in the first and second quarters of 2020.***

The Fed has acted to prevent or minimize the risk of a recession. The US consumer is feeling good, secure about their job prospects and continues to spend. Corporate earnings remain solid. These are some of the reasons why we continue to remain positive for the long term.

We hope you find this analysis to be timely, helpful and provides you with clarity and information that is understandable.

We want you to focus on your long term financial goals, not on short term moves in interest rates or stocks. However, this type of information can be helpful in keeping you on track and sticking with the financial plan that we have developed for you.

Sources:

* “Fed Cuts Rates, Signals a Pause,” Wall Street Journal, October 31, 2019, page 1

** “Consumer Spending Bolsters Growth,” Wall Street Journal, October 31, 2019, page 2

*** “Better-Than-Expected Earnings Ease Growth Fears -for Now,” WSJ.com, October 31, 2019

Fed Lowers Interest Rates, Needed or Not

Blog post #405

After raising short-term interest rates from 2016-2018, the Federal Reserve voted to lower short term interest rates by .25% on Wednesday, to 2-2.25%. At least temporarily, this ends the Fed’s efforts to return short-term rates to more normal levels. Short term interest rates were around 5% in late 2007.

As we have explained before, the Federal Reserve has a dual mandate to foster maximum employment and price stability, which they define as inflation of around 2%.

Jobs gains have been solid in recent months and the unemployment rate is low, at a 50 year low in fact. Consumer spending is solid and growing, but the “growth of business fixed investment has been soft.”*

The Fed feels that inflation, other than for food and energy, are running below 2%. They feel this is not good enough, as if an economy was expanding and doing even better, market forces have historically caused inflation to grow at 2% or above. By cutting short term interest rates to stimulate the economy, they want to slightly increase inflation to 2% or above.

The Federal Reserve in their statement Wednesday cited “implications of global developments for the economic outlook as well as muted inflation pressures” as reasons for the rate cut.* We feel this means concerns about economies outside of the US, as well as negative effects of the ongoing trade tensions.

We are not sure if these actions were completely warranted by the Fed at this time, but they can be viewed as a preventative step to keep the economy strong and possibly to avoid any further weakening. I had written that sentence after the Fed’s written statement was released and later, in his press conference, Chairman Powell said “there is definitely an insurance aspect” to the rate cut.**

The Fed also said that “uncertainties about this outlook remain.”* This does not surprise us, as we feel there always will be uncertainties of some type. No one, including the Fed, can anticipate the future or what unpredicted events could occur that will impact the future of the US or global economy.

As the Fed’s outlook was uncertain, it caused them not to clarify or signal their future moves. What the Fed did not clarify, which the financial markets may find troubling, is guidance regarding future interest rate moves. Chairman Powell was not ready to confirm that more cuts are imminent, as if this was the beginning of a multiple rate cutting cycle. He said “that’s not our perspective now” in his press conference after the statement was released. This does not mean that there will not be future cuts, it means they don’t know yet if there will be more or how many. Powell viewed the Fed actions as a “mid-cycle adjustment” to monetary policy to help the economy perform as the Fed desires.**

In a technical move, the Fed will also stop reducing the bonds which they hold, two months earlier than they previously stated, which is also a loosening of credit policy.

US interest rates are quite low now, and longer term rates have been dropping. For example, 30 year fixed mortgage rates, which at one point neared 5% in the past year, are now around 3.75%.*** You should consider refinancing if you have a mortgage that is above these levels.

The US faces the challenge of lower interest rates throughout the rest of the world, as there are now at least $13 trillion of dollars of bonds issued outside of the US that have negative yields.**** This is one factor, though not stated, that may have impacted the Federal Reserve’s decision to lower short-term interest rates.

It is important to note that the Federal Reserve is supposed to act independently of any political pressure and make their decisions based on data they observe and their economic training. They are to act in the best interest of the US economy, to achieve their dual mandate stated above. Powell reiterated in his afternoon press conference that this move was not politically influenced.

We do not anticipate or recommend any changes to your investments or Investment Policy Statements as a result of these actions.

We hope this analysis is helpful to you, and provides you with clarity and information that is understandable and timely.

If you would like to discuss your specific situation, in lieu of this news, please contact us. That’s what we are here for!

Sources:

*Federal Reserve Policy Statement, Federalreserve.gov, July 31, 2019
**”Federal Reserve Interest-Rate Decision-Live Analysis,” wsj.com, July 31, 2019
***”Rates Already Cut-For Mortgages,” wsj.com, July 31, 2019 p. A8
****”The World Now Has $13 Trillion of Debt With Below-Zero Yields,” Bloomberg, June 20, 2019

Handling recession and interest rate fears

Blog post #387

The economy and investment worries are always changing. 

Last year, many feared the impact of trade wars and rising interest rates to their portfolio. 

Most investors had portfolios that declined in 2018 but have seen a strong rebound so far in 2019.

Recently, there has been growing concern that due to slowing economic growth, stock portfolios may be at risk if there is a recession. If the US or global economies continues to slow, that could worsen and turn into a recession, which means at least two quarters of decline in the economy. 

Interest rates have dropped recently, so that some longer-term rates are now paying less than some short-term interest rates. For example, the three-month Treasury bill is yielding 2.439%, while the 10-year Treasury note is yielding 2.374% as of Wednesday afternoon. This is called an “inversion” of part of the bond yield curve. Some forecasters feel this type of “inversion” is an early warning sign of a future recession.

Should you be worried about this?

If you are not working with an experienced team of financial advisors, you could be worried. 

If you do not get clear and timely information, you could be worried. 

Why we don’t think you should be worried.

If you get advice and guidance from a financial advisor such as WWM, you have a long-term investment plan in place which is based on sound philosophies, so we don’t think you should be worried. We plan with you for these types of occurrences, even though we cannot predict when they will occur.

Recessions are very hard to predict. And when recessions do occur, they usually do not last that long, ranging from 6 months to less than two years. Since the Great Depression in 1929-1933, which lasted 3 years and 7 months, the longest recession was 18 months, from December 2007- June, 2009.*

And there is not necessarily a direct correlation between the timing of recessions and the impact on your investments. The stock market can decline before a recession starts and rise before a recession ends. We do not feel that what happens in the next 3-6-18 months, to the economy or your investments, should impact your ability to reach your long-term financial goals, with sound financial planning and investment advice. 

A recession does not mean that the stock market will necessarily incur the huge declines that were experienced in 2007-2009. That is always a possibility, as major declines generally occur at least once every 5 years, but again, these types of downturns cannot be reliably and accurately predicted in advance. 

Thus, fears about a potential recession should not translate into a change in your long-term investment plan of action. In a CNBC interview on Thursday, March 28th, Warren Buffett was asked about a potential recession and the impact of that on his investment strategy. He reiterated his belief, which we agree with, that you can’t predict when events like recessions will occur and it would not change his long-term desire to buy and hold stocks.

If you work with WWM, you have an investment plan that is developed for your personal situation. We view these plans as long term, to cover your financial goals and objectives for many years. You would have a globally diversified asset allocation mix (the amount of stocks and fixed income investments) that is appropriate for your goals and risk tolerance. 

If you work with WWM and you are in retirement, your investment plan is designed for decades, to support your desired standard of living. 

If you are saving for college or retirement, your plan is intended to suit you for many years or decades, during both good and bad stock market periods. 

We understand that at times you may have concerns or worries. If you are still worried after reading this, that is what we are here for. Call us and let’s discuss it. 

Working with WWM, we strive to guide you through the always changing economy and financial markets with a solid investment philosophy.  We strive to provide you with advice, re-assurance and clarity. 

We don’t want you to panic and sell because of fear. That could be detrimental to your financial future. Selling because of fears and downturns could reduce, not increase, your long-term goal of financial success. 

We want you to understand what is happening in the financial world, so that you will have the fortitude to adhere to your long-term financial plan. We feel that sticking to a long-term plan that we develop for you is much more likely to lead you to financial comfort and success. 

If you are not working with WWM and not receiving our financial advice, we encourage you to contact us. See the difference that we can make in your financial life. 

Source:

* “List of recessions in the United States“, Wikipedia


Major Financial Plot Twist

Blog post #386

In December and the fall of 2018, the Federal Reserve played the role of villain.

They had raised short term interest raises for five consecutive quarters and were projecting more increases for 2019 and 2020.

As a result of these increases, the Federal Reserve appeared to be Grinch-like just prior to last Christmas, which contributed to significant stock market losses in 2018. See our blog post, Is the Fed acting like Grinch?, from December, 2018. 

But in January, the Federal Reserve began changing the plot in this economic story. They went from villain to hero, at least as far as global stock markets and investors are concerned. 

Since their late December meeting, Federal Reserve officials have signaled in speeches and meetings that further rate increases may not be needed in the near term. 

This change in the Fed’s stance, though caused by their concern that US and global economies are slowing in growth, are a large factor in the strong performance of major US and global stock indices so far in 2019.

To reap the long-term benefits of investing in a globally diversified stock market portfolio requires patience and discipline. If you were patient and disciplined in late 2018, and didn’t overreact to the 2018 stock market declines, you have likely been rewarded in 2019.

The Federal Reserve announced no new short-term interest rate changes this week and projects no increases for the remainder of 2019, after their recent two day meeting. The average member now expects a single .25% increase next year, in 2020, and no increases for 2021. 

This is a major change from their position in December, 2018, when Board members forecasted two .25% rate increases in 2019, which was a reduction from their projections earlier in 2018 for three 2019 increases.

The Fed reaffirmed its stance that it “will be patient” in determining future interest rate changes, based on observed economic data (past economic activity) and expected future conditions.

It is clear once again that economists are not able to accurately predict the future.The Fed is supposed to have some of the top economic experts in the country, yet their “dot plot” forecasts of future interest rate expectations have consistently been inaccurate over past years. 

How will the economy act in the future? Will the Fed play the role of villain or hero?

We know that the future story will likely not play out as currently forecasted. There will be events and changes that can’t be anticipated. No one really knows the economic future, how the trade issues will be resolved or the pace of growth. It is likely that the Fed’s current dot plot forecasts of future short term interest rate changes will be different than they predicted this week. We don’t know when or if they will raise or even reduce rates, or the pace of the actual future changes…from what they predict now. 

This reaffirms our philosophy of not investing based on interest rate predictions. This is why we believe in using laddered fixed income holdings, spread across various maturities, and not betting on interest rate moves. This is why we don’t make stock market investments and recommendations based on predictions. 

Fed Chair Jerome Powell still expects the US economy to “grow at a solid pace” in 2019, but at a slower pace than in 2018. This is causing longer term interest rates, such as the 10 year bond, to decline even further than expected. The rate was over 3.24% in early November, 2.77% in late December, 2018 and was 2.54% Wednesday afternoon, which was the lowest level since January, 2018.

We always stress that investors need to be focused on the long-term. Commenting about these Federal Reserve changes may appear that we are focusing on the short term. However, we feel that it is important to share our thoughts and analysis about current market news and actions.

You want investment and financial advice. You want reassurance and confidence, with a future that is uncertain.

We can provide you with clarity, perspective and solid answers. 

We can guide you through financial complexity and work toward increasing your changes of meeting your financial and retirement goals. 

Talk to us.

Is the Fed acting like Grinch?

The Federal Reserve on Wednesday again increased short term interest rates by .25%, which is the fourth such increase of 2018.

This move was widely anticipated (and telegraphed by the Fed) for weeks, but recent financial circumstances made the action surprising to many analysts.

We always stress that investors need to be focused on the long-term. At times, writing this blog weekly feels like we are focusing on the short term. However, we feel that it is important to share our thoughts and analysis about current market news and actions.

So while we want to wish you Happy Holidays, Merry Christmas and a Happy New Year….the financial markets are not filling investors stockings with good cheer.

Global stock markets have declined dramatically during the fourth quarter, affecting nearly all asset classes, in varying amounts.

The price of oil has dropped over 35% since early October, due to concerns of slowing economic activity and supply increases, particularly in the US.

What do we think? Does the Fed action make sense? What happens from here?

We have often explained that the Federal Reserve has a dual mandate, to encourage full employment and price stability, which means to maintain inflation around 2%.

Unemployment in the US is at all-time lows and inflation is at or below 2%, and not likely to increase soon given the large decrease in oil prices. Based on the current data, it may be hard to understand why the Fed increased short term interest rates on Wednesday.

The US stock market reacted negatively after the Fed’s written announcement and press conference, as the Chair explained that Board members still predict two .25% rate increases in 2019. However, those are predictions and they are subject to change, based on future economic conditions. The currently projected two increases for 2019 is reduced from their internal projections earlier this year for three 2019 increases.

The Fed acts independently and we hope that their actions do not cause the economy to slow too much. The Fed is supposed to focus on their dual directives, and not react to the stock market or political pressures, which they are clearly not doing. Maybe the Fed sees the US economy as stronger than the stock market is fearing. The stock market can be very volatile and investor psychology can change quite quickly, as it has a number of times during 2018.

Short and longer term interest rates have nearly come together, as of Wednesday afternoon. This is called a flat yield curve. The 2-year US Treasury note yield is 2.68%, while the 10 year US Treasury yield is now 2.77%, declining from 3.24% as recently as November 8th.

The implications of these interest rate moves is that longer term borrowing is now cheaper than it was a month ago, which should be better for the housing and vehicle sectors, than 4-6 weeks ago.

In November, the stock market declined in response to the sharp rise in the 10-year yield to above 3.2%, but the stock market has not rebounded as longer term interest rates have dropped, due to slowing economic growth concerns.

We do not know what the stock market will do in the near future. We know that enduring losses is not easy. We wish we had a crystal ball, but we don’t.

We don’t know exactly what someone like Warren Buffett is doing right now. However, based on his past actions and speeches, we would assume that he and Berkshire Hathaway would be buyers, not sellers. He has often said it is wise to be “fearful when others are greedy and greedy when others are fearful.” In other words, when others are fearful and stock prices have dropped, it may represent a good time to buy, or at least, not a time to sell.

We feel that to reap the long-term benefits of investing in a globally diversified stock market portfolio requires patience and discipline. This is one of those times, where patience and discipline are encouraged. We feel that in the long term you will be rewarded.

We are here for you, if you want to talk to us, to review your portfolio or discuss your concerns.

Happy Holidays!

Market Update

We always encourage you to focus on the long term.

We plan and allocate your investments so that you will have adequate liquidity to meet your short-term financial needs.

We don’t know how the future will evolve, but we do our best to plan, knowing that the reality is unknown.

While stressing our long-term focus, sometimes analysis and thoughts about short-term market actions and news can be helpful to you.

In general, worldwide stock market indices have declined since September 30th. US and worldwide stock market indices increased in early November (see blog dated November 8, 2018), then declined most of November, with a strong recovery this week, since Thanksgiving.

The decline of worldwide stock market indices since September 30th can be attributed to investor psychology regarding the following:

  • Slowing global growth
  • Trade tariff impact
  • The huge decline of oil prices since early October
  • Concern about rising interest rates in the US (see the above cited blog post)
  • Valuation concerns about some sectors or individual stocks may have been overvalued

Most of our clients have significant fixed income allocations. For illustrative purposes, let’s say someone had a 50% stock and 50% fixed income allocation. Though the financial markets have declined for the year, a balanced portfolio would not be down double digits on a percentage basis for the year to date. While not what we expect long term returns to look like, it is not anywhere near the losses incurred in a major down market.

We remain confident in our major investment principles, which include:

  • Being globally invested for the long term
  • Using very low-cost asset class mutual funds and not individual stocks
  • Not trying to pick which stocks, sectors or regions will do best
  • Owning high quality fixed income and not junk bonds
  • Avoiding hedge funds and alternative investments, which lack transparency and can be very expensive
  • Over-weighting to value and small company asset classes

On Wednesday November 28, US Federal Reserve Chair Jerome Powell gave a key economic speech. He first discussed his outlook for the economy and interest rates. He then explained in-depth the Fed’s approach to monitoring and addressing financial stability. I found both aspects of his speech to be very insightful and they gave me confidence about the future.

While not everyone will be interested in the full speech, I highly recommend reading this speech, or at least the pages 1-2 about interest rates and pages 13-14 summarizing his thoughts about financial stability. The highlights of the first part of his speech are below. I will likely write about the latter part in a future blog post. The speech is very readable. It shows that the Fed is trying to effectively communicate, as well as look at the financial world and attempt to identify future problems before they become severe.

Powell explained that the Federal Reserve has two jobs, to promote maximum employment and price stability (keep inflation around 2%). He stated that “our economy is now close to both of these objectives.”

The real news which caused the stock market to increase significantly on Wednesday were his comments that the financial markets interpreted that interest rates will not need to be raised much further. He explained that while interest rates are still low historically, “they remain just below the broad range of estimates of the level that would be neutral for the economy-that is, neither (causing the) speeding up nor slowing growth.” (WWM inserted “causing the”)

Powell said he, along with his Federal Reserve colleagues, and many private sector economists, are forecasting “continued solid growth, low unemployment, and inflation near 2 percent. There is a great deal to like about this outlook. But we know that things often turn out to be quite different from even the most careful forecasts.” (Emphasis added)

Powell then went on to discuss the balancing act that the Federal Reserve has, that they are dealing with uncertainty and there is no pre-set path for future interest rate moves. Because no one can predict future events, which cumulatively will affect the Fed’s future interest rate decisions, Wall Street will play a guessing game and this leads to volatility in the financial markets. While all this occurs in the short-term, this is where we remain disciplined and focused on the long-term.

Our bottom line from this speech….

  • There will very likely be a short-term interest rate increase of .25% in December.
  • We stated in our November 8th blog post that there will likely be two or three .25% short term interest rate hikes in 2019. After this speech, it’s possible that there may less. The Fed will monitor and evaluate how the economy is performing and review its forecasts at each of their meetings.
  • Powell does “not see dangerous excesses in the stock market.” He made this comment in the latter part of his speech, when he was focusing on financial stability. He distinguished market volatility, which is normal and expected, from events that could threaten financial stability.

We hope this analysis is helpful to you.

If you have further questions, please contact us. That is what we are here for.

Fed Continues Interest Rate Increases and Spain (Part 2)

On Wednesday, the Federal Reserve raised short term interest rates by another .25% point. They increased the benchmark rate to a range between 2-2.25%. This is the 8th .25% increase since late 2015 and the third such increase this year.

Based on Fed officials’ projections, they expect to increase rates by another .25% later in 2018, 1% in 2019 and at least one more .25% increase for 2020. This indicates the short term benchmark rate would be slightly higher than 3.25%.

This will mean that for the first time in a decade that short term interest rates will be higher than the rate of inflation, which is currently around 2%.

Fed Chairman Powell said in a news conference that “these rates remain low. This gradual return to normal is helping to sustain this strong economy for the longer-run benefit of all Americans.”

The Fed eliminated the term “accommodative” from the statement they issue after each of their meetings. This and similar terms have been a part of Fed statements since the financial crisis in 2008. Going forward, the Fed will continue to balance their dual obligations to maintain an inflation rate of approximately 2% and the level of unemployment, which is currently low.

The impact on you and your investments

  • Short term interest rates have increased quite significantly over the past year. This will benefit you as the interest income you will be earning on the fixed income portion of your portfolio will gradually increase over the next years, as older investments mature.
    • For example, the 2 year US Treasury Bill yields 2.83% today, whereas it was only 1.48% a year ago.
  • Longer term rates have increased, but to a lesser extent than shorter term rates. Thus, we will continue to invest fixed income portfolios over various years, but in shorter maturities.
    • The 10 year US Treasury Note increased from 2.31% a year ago to just over 3% today.
  • You should make sure that you do not have excess cash in bank accounts that are still earning hardly anything, as even interest rates on very short term investments are beneficial.
  • We remain positive about the economy, as well as both US and global stock markets. While increases in short term interest rates may slow down certain aspects of the economy, the Fed appears to be working towards managing the economy so that it does not overheat and cause inflation to be much greater than 2%.

Spain

Felicia and I completed our spectacular trip to Spain on Tuesday.  We visited Barcelona, San Sebastián, Bilbao and Madrid.

 

 In Madrid, we visited the world’s oldest documented restaurant, Botin, established in 1725.
Our tour guide took us to the central point of Spain, near the middle of Madrid.  It is traditional to place your feet on the marker, to safely return for a future visit.
 
 We enjoyed great food throughout our trip.  One highlight was very fresh and great tasting produce, meat and seafood.
We are very fortunate to have taken this trip and look forward to more travels in the future!

The financial markets today and going forward

The stock markets in the US and the world continue to be very rewarding for most investors.

If you are broadly diversified, you should be benefiting from solids gains over the past years.

We see the economy as continuing to be strong and the majority of companies continue to report good revenue and earnings growth. Companies which are not growing or are being impacted by innovation and strong competition (many retailers, grocery store chains and energy companies, for example) have seen stock market returns far below the general market averages.

Stock market returns are correlated to current and future earnings expectations of companies. Over time, greater earnings result in higher stock prices. For evidence of this, take a look at GE and IBM over the past decade and Under Armour, which declined over 20% in one day this week after reduced sales expectations.

In the short term, stock market returns can be impacted by politics, but long term returns are not driven by politics. Our best advice is to ignore day to day politics and focus on the long term growth of the great companies of the world.

One of our core principles, grounded in academic financial research, are the following relationships: small stocks outperform large stocks, value stocks outperform growth stocks, International stocks outperform US stocks and Emerging Market stocks outperform US and International stocks. While our recommended portfolios have exposure to many asset classes, we recommend exposure to small, value, International and Emerging Market stocks, as they have greater long-term returns.

While these relationships do not hold true every year, we believe they are valid and will be rewarding for disciplined investors who are patient over the long term.

While valuations of certain individual stocks and some US indices seem quite high, the returns of some major indices have been driven by the performance of a small number of companies. The Dow Jones Industrial Average (DJIA) is comprised of 30 stocks. The WSJ reported yesterday that Boeing alone accounts for most of the DJIA’s gains for this year. For October, 3M, Apple, UnitedHealth, Caterpillar and McDonald’s accounted for over half of the DJIA’s gains. Our globally diversified stock portfolios consist of thousands of stocks, so your returns are broad based and not due to just a handful of companies. This should be reassuring to you.

As markets have risen, many commentators have stated that valuations are excessive and others ask if it is time to get out of the market. Valuations are much more reasonable for the asset classes we focus on, particularly considering that global interest rates are still historically low. The asset classes we recommend greater exposure to, such as small value companies, International and Emerging Markets, are cheaper than many major US stock indices (such as DJIA, S & P 500 and NASDAQ) based on various valuation metrics. Thus, given that these asset classes have provided solid returns and are still cheaper than many US stock indices, we are confident in our portfolio positions.

This does not mean that a market decline or correction cannot occur in the near term. On the contrary, markets are long overdue for a 10% or greater decline, on their longer term path higher. However, we would not recommend changing your stock allocation today just because of the gains of the past years.  Those who have not been invested in the stock market, who are concerned or have been waiting for a pullback for the last year or two, are far behind those who have stayed the course and remained invested according to their written investment plan.

Our investment strategy of monitoring your portfolio to maintain your appropriate allocation to stocks provides you the benefit of discipline and the reward of “selling high.” We are disciplined about rebalancing throughout the year, not just at year end. We do not sell an entire asset class, such as completely getting out of emerging markets because it has outperformed this year. We may take some profits, but still leave exposure to each asset class.

We are positive about the announcement of the new Federal Reserve Chairman, Jerome Powell.  His appointment requires confirmation by the Senate.  He is expected to continue along the same path as Chair Janet Yellen, who has managed the transition of the Fed well during her 4 year term, which ends February 5, 2018. The US stock market had strong gains during her 4 years as Fed Chair. We expect Powell to lead in the same manner in the future, with gradually rising interest rates over the next few years, with some commentators suggesting he may be less restrictive from a regulatory standpoint.

The world is constantly changing. No one can predict the future. We could not have predicted the success of Apple, Amazon or Facebook’s stocks 10-15 years ago. But we also don’t know how these stocks will perform over the next 10-15 years. Past performance does not guarantee future returns.

Similarly, we could not have predicted 10 years ago that Bed Bath & Beyond would be worth much less today, Merck would be worth about the same and Exxon Mobil would be worth less than it was in 2007. These are just a few examples of why we believe in the broad diversification of using asset class mutual funds, which have dramatically increased in value over the past 10 years.

This week’s takeaway:


The asset class funds which we recommend are very broadly diversified and hold thousands of stocks. Their returns have been solid and not concentrated in a few stocks. There are some major indices whose increases are due to a small number of stocks. Also, the valuations of the asset classes which we overweight are more reasonably valued today than major US indices. This should be reassuring for our clients.