Investing implications of Coronavirus outbreak

Blog post #431

As of now, the coronavirus has not had a material impact on the investments of our clients.

US and global stock markets have generally been quite resilient and have held up well so far, despite the ongoing health issues, which have led to various consequences in China and are impacting other parts of the world.

We cannot make any predictions or forecasts of what the future will hold or what the full impact of the coronavirus will be. As global health officials are not able to do this, we certainly cannot anticipate what will occur in the coming weeks or months.

We do not recommend making any specific investment changes due to the coronavirus outbreak. As we have discussed in the past, to try to “trade” or “time the market” based on a specific event, you must be correct in your timing…twice. As markets react to news and information so quickly, as well as rumors, this is not likely to be a successful strategy.

While it is very possible that global stock markets may incur losses or more volatility due to the coronavirus, we feel a strategy of adhering to your long-term investment plan and asset allocation makes the most sense.

Companies based in the US and globally will be impacted, but to varying degrees. Companies are not able to anticipate or determine what the impact will be, or very few companies have released specific statements or changed their earnings guidance. It is likely that some firms, and their stocks, could be affected, such as companies that have major businesses in China (such as Starbucks and luxury retailers), companies that rely on travel to or from China (such as certain airlines, hotels, luxury retailers and the gaming industry), or companies based in China or that rely on China for the manufacturing and supply of products (Apple, for example).

We want our clients to know that they have very little direct exposure to companies that are actually based in China. For example, if you have a 60/40% stock/fixed income allocation, Chinese-based companies account for approximately 2-3% of the globally diversified portfolio that we recommend.

However, it is important to note that the impact of the coronavirus may globally extend beyond companies that have historically relied upon Chinese consumers, Chinese tourism and spending for a significant part of their revenue and profits. The virus may lead to issues for companies on a global basis that rely on Chinese companies as part of their supply chain. These companies would be held throughout a typical portfolio and the impact cannot be determined.

There may be short-term impacts and stock market swings based on health reports, either positive or negative, due to the coronavirus. Volatility may increase if the coronavirus outbreak persists in China or spreads in a more significant manner to other parts of the world, or the US. The stocks of individual or groups of companies may begin to be impacted more as they are better able to assess and report changes in revenue and future earnings expectations due to the impact of coronavirus on their business.

Interest rates have dropped in the US, due to the coronavirus. This has created another opportunity for mortgage refinancing, or low rates if you are looking to purchase a house, as mortgage rates for 15 and 30 years are extremely low. The price of oil and some other commodities have dropped significantly due to the reduced demand, because of the major shutdowns occurring in China.

We want to emphasize that if you have specific financial concerns or want to discuss the impact of this situation to your portfolio or financial future, please contact us.

While we stress a long-term approach to investing, if you have short term concerns, now is the time to talk to us about that. That is what we are here for.

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

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!

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!

Fed Reserve, Stock Market Actions and a WWM Milestone

The Federal Reserve again increased short term interest rates by a quarter of a percent on Wednesday. It signaled that it will do the same twice again later this year.

This is good news, as the Federal Reserve’s actions to regularly increase interest rates is reflective of the strength in the US economy. The Fed noted that economic activity has risen “at a solid rate,” which is an upgrade from their May statement, when they called economic activity “moderate.”

Federal Reserve Chair Jerome Powell stated in a press conference that the US economy is in “great shape” and that “most people who want to find jobs are finding them.”

It is important to understand the Federal Reserve actions and comments are not considered stock market forecasts. They are economic updates and future economic guidance, which are not always accurate.

The Federal Reserve actions are reflected in the significant rise in short term interest rates over the past year, as shown in the table below. However, as the Federal Reserve cannot directly control longer term interest rates, those rates have risen, but not nearly to the same degree as short term interest rates.

June 2017
June 2018
2 YR
US Treasury Note
1.37
2.56
10 YR
US Treasury Bond
2.21
2.96
30 YR
US Treasury Bond
2.78
3.07

 

Note that the current spread is quite small between the 2 year interest rate and 10 year interest rate, of only around .4% (2.96%-2.56%). There is hardly any increase or premium in the interest rate between the 10 and 30 year maturities. This is what is referred to as a flat yield curve, as there is not much of an increase being paid to hold longer term fixed income securities.

In a more normal, steepening yield curve, the interest rate would gradually increase as the maturity lengthens. In a steep yield curve environment, the 30 year bond would pay much more than a 10 year bond, which would pay more than 5 or 2 year maturities.

What does this mean and why?

Some forecasters say that a flattening yield curve is a sign of a future economic downturn, or a recession. We do not necessarily believe this is the case, at least in the near term.

This situation will present a challenge for the Fed if longer term rates do not increase in the next 6 months. If the Fed increases short term interest rates .25% in September and again in December, or faster, then short term rates would be around 3%, which is equal to or greater than long term rates now. This would be called an inverted yield curve, when short term rates are higher than long term interest rates. If this were to develop, it is not necessarily indicative of a problem or a bad thing, it is just unusual for a healthy and growing economy.

As it affects our clients and our investment strategy, rising short term interest rates provide an opportunity for those who own fixed income investments, such as bonds or CDs, to earn more interest on their fixed income allocation. This has been a long time in coming.

As your current fixed income investments mature, we will reinvest them at greater interest rates than before, so your interest income will increase. Over time, this should be a significant increase in interest income.

We do not place major bets on the direction of interest rates by bunching maturities all in one year. We always evaluate the interest rates and various maturities which the market offers at that time, for the most beneficial combination. It is possible that we would buy a little bit shorter maturities now than we would have a few years ago, as there is not much premium to hold fixed income investments beyond 5 years. But fixed income markets can change quickly and we would react as appropriate.

As a reminder, when interest rates rise, the value of your fixed income investments will decline temporarily in value/price and then that price will recover as they near maturity. You should not be concerned about these temporary declines, see our recent blog post, Why Bond Fluctuations Should be Ignored.

The US stock market has been strong in the second quarter of 2018, with small and value asset classes outpacing the large company S&P 500. International and Emerging Markets have trailed these asset classes during the current quarter.

We remain confident in our long term investment strategy and philosophies, as they continue to be profitable for our clients.

This week marks a writing milestone, my 200th blog post since I started writing weekly four years ago. This is the 4th straight year that I have written nearly every week since June, 2014.  Prior to that, I had sporadically written 145 essays between 2009 and April 2014.

Writing weekly is one of the most important services our firm provides to our clients, as we can communicate in a very timely and regular manner to you. We can convey and reinforce our investment philosophy, principles and beliefs in real time.

These are intended to be relevant and informative.  Reading these blog posts regularly, you should have greater clarity about your investments.  You should have more confidence in our philosophy, especially when the financial markets are challenging.

Hopefully, you better understand the benefits of being rationally optimistic, focusing on the long-term and on what you can control, rather than on the day-to-day news and market volatility.

I am convinced that we are better financial advisors by writing these weekly blog posts.  We are passionate about being excellent advisors.  Writing makes me think.  We are more aware of questions and issues our client raise, as these are likely future blog topics.  We are more curious.  We research topics to provide information which will be useful to you.

When I committed to writing every week, it took courage.  I didn’t know if I would be able to do this every week.  I didn’t know if I would have the discipline.  I enjoyed writing earlier in my life as a high school newspaper editor.  The weekly commitment gave me structure, which led to developing greater capability.  The more blog posts I completed, the greater my confidence has grown.

This concept also applies to each of you, as our clients.  At one time each of you made the decision to work with our firm as your financial advisor.  This took courage and commitment.  It was likely a significant change for you.  As you become more comfortable with our capabilities, your confidence in our advice and philosophy grew.

Thank you for your confidence and for reading!

10 Things You Should Know

  • Economic forecasts and stock market movements are often not the same. Even though most people think the US economy is stronger than Europe’s, International stock markets are doing better than US stock markets so far in 2017.
  • Expect the unexpected. Conventional wisdom frequently is wrong.
    • It does not look like corporate or individual tax reform is going to get completed in the coming months. There are no real proposals on the table. The initial goal of Labor Day looks unlikely. Will this get done by year end?
  • To be a successful investor over the long-term, it helps to have a clear and consistent investment philosophy. This is why we develop written investment policy statements for all of our clients.
  • Interest rates are very hard to predict. Short term rates have increased. Longer term rates have gone down, despite nearly all forecasters predicting the opposite at the beginning of 2017. This is why we don’t make interest rate bets with your fixed income investments.
  • The price of oil continues to fluctuate around $50-55 per barrel. There was a large price decline this week, as US shale oil production continues to increase. Output is expected to rise by 124,000 barrels a day in the US during May. Rig count has risen 13 weeks in a row and is at a 2 year high.
    • US production puts a cap on oil and gasoline prices, which is good for US consumers and companies that use oil to produce goods. Not so good for oil and related companies.
  • Uncertainty is the only certainty. By investing in broad based index-like funds which we recommend, you are better able to handle uncertainty.
  • The following statistics are startling and provide further confidence in our stock investing philosophy of using globally diversified asset class funds, which track various benchmarks:
    • In a just released SPIVA US Scorecard** report, during the 5 years ending December 31, 2016, 88% of large-cap managers, 90% of mid-cap managers and 97% of small-cap managers underperformed their respective benchmarks.
    • During the 15 years ending December 31, 2016, the same report showed 92% of large-cap managers, 95% of mid-cap managers and 93% of small-cap managers underperformed their respective benchmarks.
    • If you are not a client, do you know if your fund managers or your individual stock portfolio are underperforming or out-performing their respective benchmark?
  • Some investors hold individual stocks long-term because they value the high dividends the companies pay. However, the dividends can come at a huge opportunity cost, if the underlying stocks vastly underperform major benchmarks over the long term. Investors in IBM, Verizon, American Express, Coke, many utilities, and energy related stocks and limited partnerships would have been far better off financially with broader investments, even though they would have received less in dividends.
    • For example, these companies have dramatically underperformed the S&P 500 over the past 5 years: IBM (15%) per year, Verizon (4.2%) per year, American Express (6.6%) per year, Coke (7.6%) per year and Enterprise Products Partners, a major oil and gas infrastructure firm (7.5% per year).
  • Sometimes stock market valuations do not make sense. Tesla produces a tiny fraction of the cars made by Ford or GM, yet Tesla’s stock market capitalization is more than each company. Tesla’s Gigafactory being built in Nevada will be the world’s biggest building, with over 5.5 million square feet, or approximately 100 football fields. We won’t know for many years whether Tesla will be successful or not, or the future direction of its stock. By being broadly diversified, you can benefit from its success or not be dramatically hurt if the stock does poorly.
    • One of the benefits of our investment strategy is broad diversification and not having to make individual stock decisions like this. Around 1999-2000, when Amazon was taking off, I never thought its stock price made sense. It always seemed highly overvalued. However, through the phenomenal growth of its Amazon Web Services and online sales, it became profitable and investors have benefited.
  • The long-term historical perspective which we provide as advisors can help you to be more financially successful. It is how you can be rational in the face of uncertainty and deal with the onslaught of news events and the rapidly changing world.
    • Perspective, planning, discussions and comprehensive advice on topics such as investments, tax management, charitable giving and estate planning all provide you with peace of mind and security.
**Source: Spiva US Scorecard Year-End 2016, produced by S&P Dow Jones Indices.

When Should Strategy Be Changed

Yesterday, the Federal Reserve increased short term interest rates for the first time in 2017 and just the third .25% increase in short term rates since 2009.

Prior to the Fed announcement, I was contacted by a Detroit Free Press personal finance reporter for my comments. She wanted to know what would happen to the stock market, are we changing our investment strategy and our outlook for future interest rates.

Our reply to the Detroit Free Press was the following:

“We expected very short term interest rates to rise by .25% at this week’s Federal Reserve meeting. We anticipate that there will be at least two-three additional .25% short term interest rate increases during the remainder of 2017. We view these as positive, as the economy continues to be strong and not headed into a recession. While it is difficult to predict the future, it is reasonable that the Fed will continue to increase short term rates throughout 2018, if the economy continues to remain strong and there is an infrastructure plan enacted.

We are not changing our investment strategy based on the Fed actions. We have a long term investment strategy to have our client’s very diversified, both in the US and internationally, so we would not recommend changes based on just today’s Fed actions. We have recommended that client’s should refinance mortgages, if they have not done so already. While we are positive about US and global stock markets for the long-term, we have been reminding clients that there has not been a significant stock market correction in over 9 months. Thus, a temporary decline, in the midst of a long-term rising market, should be expected and considered a normal occurrence.”

We were quoted in the Detroit Free Press article on the Federal Reserve action, which you can read here.

Changing a strategy should be based on evidence that a current strategy is not working or that evidence exists that modifications would be necessary or a better strategy exists.  The principles and general investment philosophy which we adopted when we formed our firm in 2003 are still valid and have stood the test of time.

We are disciplined and have a strategy that is well defined and transparent, which we adapt to the individual needs of our clients. The stock mutual funds that we have utilized since inception have excellent track records, over the long and short term, especially when compared to their respective category peers. They are some of the lowest cost mutual funds in the industry as well as provide excellent tax management, to minimize your taxes, as applicable.

We have avoided hedge funds, alternative investments and junk bonds (higher risk fixed income products) and making bets on certain sectors, such as energy. We are confident that these decisions were correct and have been significantly to your advantage. As Warren Buffett and a great deal of other evidence shows, most alternatives and hedge funds do not provide the long-term performance or diversification benefits which they claim.

If you are not a client of our firm, you may think you are doing well. But do you really know? That may be a relative term or feeling, until we meet and review how well your portfolio has performed or how your investments are structured.

  • When we meet with prospects, we nearly always find that their existing portfolios are:
    • taking too much risk in certain areas,
    • under-invested in asset classes that have higher expected returns
    • more invested in asset classes or individual stocks which have lower expected returns
    • paying more in fees than they should be
    • not being managed in a manner which reduces their taxes as much as they could be
  • All of our current clients were formally prospects. Nearly all of them formerly worked with other advisors, but after they met with us, they understood our rational approach to investing and the other benefits we could provide.

We are confident in the future and confident in our investment strategy.

Fed Reserve: Why rates are increasing

The Federal Reserve this week finally did what they have not done since last December, increasing the federal funds rate to ½ to ¾%. This increases very short term interest rates by .25%.

The Fed Reserve action trails the actual rise in interest rates which has occurred since the Presidential election.

The trend in interest rates since December, 2014 is as follows:
  • Most interest rates rose during 2015, both long and short term.
  • During 2016, short and longer term interest rates were expected to rise, but actually declined significantly from January, 2016 through the fall, 2016.
  • After the election, short and long term interest rates have increased significantly, especially in relative terms.

Irrespective of the Federal Reserve, the financial markets moved interest rates higher based on increased future expected economic growth and Federal spending as a result of the election.

See the following chart for how interest rates have moved over the past two years:

table-a

The Federal Reserve can heavily impact very short term interest rates. The financial bond markets, and really their expectations of future economic activity, controls the future of mid-longer term interest rates.

While it is important to understand the thoughts and forecasts of the Federal Reserve, you should realize that financial markets control much of the interest rates that really matter, such as the corporate debt, mortgage rates and longer term US Treasury debt.

The Federal Reserve provides economic and monetary projections quarterly. While these projections have generally been inaccurate during the past few years, they are still important to consider.

The following are the projected federal funds rate data from the forecasts of December, 2015, September, 2016 and December, 2016. You should note that while the forecasts for short term interest rates have increased from September to December 2016, those forecasts are still much lower than as forecasted 12 months ago.

table-b

The major change from the September, 2016 to December, 2016 median forecast for 2017 is raising rate hike expectations from two .25% increases to three .25 increases.

Conclusion: Less emphasis will be placed on the Fed in the next year. Expectations of policy changes have caused interest rate increases since the election. As policy and legislation are enacted and implemented by the new administration, their impact on the economy will have much greater influence on the movement of interest rates.

If the economy grows faster than expected, employment continues to be strong or stronger and if inflation becomes greater than 2% annually, for whatever the reason, then interest rates will likely rise greater than the Fed’s forecasts.