Friday, June 30, 2017

3Q-17 Investment Meeting Summary

We held our Q3-17 investment strategy meeting on June 28. The most significant changes we made following our deliberations were, in the equity area, an increase in our exposure to international equities, more specifically Europe; and within the fixed income area, a very slight reduction in our allocation to short term bonds.

We continue to remain positive for the outlook for the global economy. We see the U.S. economy accelerating somewhat this year and next in the range of 2.5% or a bit higher in terms of real GDP growth with the potential for stronger growth in 2018. This is positive for corporate profit growth, the primary driver of stock prices.  What has been driving the stock market higher of late, in our opinion, is rising corporate profits. In the first quarter of 2017, corporate profits rose at an annual rate of about 9% and are currently forecast by Factset to grow at about 10% for the full year in both 2017 and 2018.  The trend of rising corporate earnings should provide support for higher stock prices assuming valuations remain steady.

One problem or “issue” for U.S. equities currently is valuation. The U.S. stock market as reflected by the S&P500 is currently trading at around 18.5x this year’s expected earnings. This is approaching the upper end of the market’s long-term valuation range of around 12-20x. This does not imply that the stock market cannot go higher;  we believe it can based on our outlook for the economy and rising corporate earnings. However, it does reflect an element of risk for equities that needs to be considered in our investment policy and risk management.

There are several ways in which we manage risk in your portfolios. One is through diversification of your investments by asset class (e.g., stocks, bonds, commodities, real estate, etc). This helps to dampen portfolio volatility while providing a more stable long-term return. Other ways in which we manage risk are through changes in tactical strategies following our quarterly meetings and through our selection of securities holdings that we believe will best serve you in implementing our strategies. One of the ways we are currently mitigating the risk of higher U.S. stock valuations is through allocating more equity investments towards international stocks such as Europe, which currently have lower valuations than U.S. stocks. Another way we are actively seeking to mitigate portfolio risk is through a relatively high exposure to “value” stocks, which tend be dividend-paying and less volatile than growth stocks. The goal is delivering the best risk-adjusted return we can and an important element in achieving this goal is reduction of portfolio volatility.

Within the fixed income area, there were no major strategic changes. We continue to remain underweight in the long-maturity sector because we believe interest rates could continue to rise based on Fed policies of normalizing the Fed funds rate and reducing its bond holdings built up during the period of “quantitative easing”. We maintained a normal/neutral weighting in the intermediate bond area and continue with our overweight of short maturity bonds. These allocations are intended to keep your effective duration at a below average level. We expect a below average duration should help to mitigate the capital impact of further increases in interest rates.

Robert E. Toomey, CFP, CFA
Vice President, Research

Friday, March 31, 2017

2Q-17 Investment Meeting Summary

We held our second quarter investment strategy meeting on March 28, 2017. If I had to pick one word to encapsulate the meeting, it would be “steady”. For 2017, we continue to expect moderate, steady GDP growth and moderate inflation, both in range of 2-2.5%. We see a moderate but steady improvement in European economy. We see Federal Reserve policy remaining steady with the likelihood of two more interest rate hikes this year. U.S. corporate profits are now back in a growth mode and we expect further improvement over the next several quarters. Valuation at 18x forward earnings is somewhat elevated, but not at levels that would prevent further improvement in stock prices, in our view. Overall, the fundamentals for the U.S. stock market remain constructive, in our view.

On the fixed income side, we believe interest rates will continue a gradual increase in 2017 based on slightly stronger GDP growth and Fed policy. As a result, we continue to keep bond durations on the shorter end. We continue to underweight long duration and overweight shorter duration as a way of mitigating the impact of rising interest rates on fixed income investments. While we expect rates will rise, inflation still remains moderate, which supports our view that the rise in interest rates should be gradual.

With respect to changes in investment holdings, the theme here is also “steady”. We made no changes to individual ETF holdings; and macro allocations to the both equity and fixed income remained very close to last quarter with aggregate equity allocation up slightly and fixed income remaining the same. Within equities, we continue to favor value over growth because we believe value stocks could perform better in a rising interest rate environment due to their perceived stronger cash flow relative to growth stocks. Our allocation to international stocks remained virtually unchanged while our allocation to real estate (REITs) was reduced slightly due to their perceived interest rate sensitivity. We continue to maintain a position in the biotech industry (IBB) as we believe it offers attractive value within a growth industry. We also maintained a position in homebuilders (ITB) as we believe a) the sector remains significantly under-built in this economic cycle and b) the group continues to present attractive relative earnings potential.

Bob Toomey, CFP®/CFA®
Vice President, Research

Thursday, February 23, 2017

Research Director’s Monthly Comment: February 2017

Surprises In Retirement

 I recently read an interesting article in the Wall Street Journal about things people did not anticipate in retirement.  As financial planners, retirement and retirement planning comes up lot in our work with clients.  In reading the article, a couple of things stood out about what folks saw as the biggest surprises in retirement: 1) what happens when you take risks; and 2) retirement nest eggs are working as planned.

 By “taking risks”, the interviewees were talking about trying something that was out of their comfort zones usually in a way that improved their lives or tapped a long-desired but postponed endeavor, like painting or music. The arts are one of the best ways to plumb the human soul, a soul that can get squelched over 30-40 years of corporate life. The “risk” for people doing this in retirement was the deep fear of being no good at it, or feeling they would never be able to learn something like art or music. It is a good thing that at this point in their lives, these folks feel they can take the risk and get closer to their own souls.

The other interesting surprise was that, at least for these interviewees, their retirement nest eggs were working out as planned. Granted, most of these folks were retired corporate or professional types. As a group, I would believe these types of folks were/are more inclined to be more disciplined about retirement savings. They were lucky, but they also had discipline around retirement savings and investment. The point of this is virtually all of us can significantly improve our odds of a happier retirement through disciplined savings and investing.
Another interesting surprise that many of these people found out was the realization that you will spend 100% of your pre-retirement income in retirement. We always assume in our retirement expense assumptions that people will spend at a level at least equal to that of their working years particularly in the first 10-15 years of retirement. We also include an expense projection for medical costs. A number of the interviewees mentioned that medical insurance premiums were growing at a rate higher than they anticipated and this was a concern for many of them. We believe incorporating medical cost projections into a retirement capital projection is imperative.
One parting thought on achieving a happier retirement: one needs to act proactively to prepare as best they can financially. This preparation takes discipline: discipline in savings, investing, and spending. A sound financial plan that includes a retirement capital analysis can also help in achieving this important goal (financial preparedness) and in achieving peace of mind that one has done all one can to prepare for it.

Bob Toomey, CFA®/CFP®
Vice President, Research

Monday, January 30, 2017

Research Director Monthly comment: January 2017

Fearless Forecasts and Financial Planning

This time of year in our industry, we get all the pundits out with their fearless forecasts for the financial markets for the coming year. After reading these for the past 30 years, I have come to learn that these forecasts have to be taken with a grain of salt. Why? Because statistics show that the pundits are correct about half the time, the statistical equivalent of a coin toss.

An interesting irony this year, and one thing that has been quite confounding to the pundit crowd of late, has been the recent Presidential election. Most pundits had assumed if Trump won, the stock market would tank. As the market usually does a good job confounding the consensus, it is up about 9% since the election and has been recently achieving new record highs.

What is behind the gain in the market that has confounded the experts? Primarily the belief the new administration will actually succeed in implementing several things that are favorable to business. This includes a reduction in corporate tax rates, potential for increased infrastructure spending, and potential for reduction in business regulations. All of this has positive implications for corporate profits, which is the primary driver of stock prices. And with a Republican majority in Congress, a lot of this may actually get done. Some people say it’s crazy, it’s not real. But the market is simply reacting logically to what it perceives may happen.

A corollary to this is while many pundits have been forecasting tepid gains for the stock market in 2017 (consensus is 5-7% total return), there is reasonable potential for the market to return more than this, perhaps significantly more, if these changes and legislation come to fruition. They would have a powerful effect on corporate profits, which may not be fully discounted yet by the market.

So what does all this have to do with financial planning? To be truthful, not much. We don’t put a lot of “stock” in the forecasts of the great “punditry”.  Similarly, when we put together a financial plan and set an investment policy, we don’t try to guess what the market is going to do (i.e., time the market); rather we look at long-term trends in returns in asset classes which we believe provide a better guide for estimating long-term growth in client assets. By diversifying portfolios across multiple asset classes, we capture growth in those asset classes while reducing portfolio volatility and delivering a more stable long-term return. True, while an all-stock portfolio may outperform a diversified portfolio in a strong equity market, an all-stock portfolio will most likely have materially greater downside than a diversified portfolio in a severe stock market decline. This is borne out in the long-term record of diversified portfolios, which have delivered superior risk-adjusted returns than an all-stock portfolio primarily because they are less volatile. We believe risk-adjusted return is arguably the most important measure of performance in wealth management.


Thursday, December 22, 2016

1Q-17 Investment Committee Meeting Summary

We held our 1Q-17 investment strategy meeting on December 21, 2016. It was an interesting and fairly momentous meeting given the recent Presidential election. The outcome of the election adds an element of uncertainty that makes forecasting a bit more difficult currently. While there has been a lot of media coverage about what Trump’s strategies may be in areas such as foreign and domestic policy, defense policy, taxation, healthcare, and fiscal policy, it is still uncertain how all this will play out.

Based on what we have seen so far, it would appear that a Trump administration could be reasonably pro-business. Trump himself comes from the business sector and appears to be bringing into his cabinet a number of people with high profile business backgrounds. If the new administration is going to take more of a “pro-business” approach, on the surface it would appear to have positive implications for the economy and hence, the stock market. But again, at this point, “visibility” into the new administration and its policies is limited.

As of now, there does appear to be better visibility for some of the key factors that drive the stock market, the two most important being valuation and corporate profits. After 4-5 quarters of declines, corporate profits are now expected to grow 8-10% in 2017, which is a positive. Stock valuation is not exceedingly high. We estimate the forward P/E on S&P500 is now about 17x. This is above the long-term average of about 15x but not in a range that would be a material impediment, in our opinion, and certainly not excessive when compared to bond yields. The outlook for the U.S. economy remains stable. We continue to expect more of the “2+2” economy: 2% GDP growth and 2% inflation. And while we believe the Fed will raise rates again in 2017, we expect it will remain cautious and deliberate in its moves, which should not be overly disruptive to the stock market. These factors support a continued constructive outlook for U.S. equities. China and its economy, in our view, continues to be the greatest risk for global financial markets and is one reason why we decided at our meeting to eliminate a position in emerging markets.

With respect to changes in your portfolios following the meeting, overall equity exposure was reduced very slightly, about 2%, while fixed income exposure remained essentially unchanged. The slightly lower equity exposure should help to buffer against what could be increased market volatility in the new year. Within sectors, we slightly reduced our exposure to mature equity and increased exposure to small cap stocks. We think smaller cap stocks could stand to benefit more from the potential for lower business taxes currently being discussed by the incoming administration. Within the international sector, we eliminated exposure to emerging markets and added a position in large-cap European stocks. The investment in European stocks is based primarily on valuation which remains very attractive. We reduced our exposure to REITs by about 8% as we believe returns in the sector could be more muted in a rising interest rate environment. Within commodities/natural resources, we eliminated positions in gold and energy and replaced these with the Flexshares Global Upstream Natural Resources ETF (GUNR). We like this ETF because it has nicely balanced exposure across five important areas: energy, metals, agriculture, timber and water. Within the fixed income area, there were no significant changes and we continue to maintain a shorter duration by overweighting shorter-term bonds and underweighting long-term bonds.

All of us at S.R. Schill & Associates wish you and your family a very happy holiday season and a happy New Year !

Bob Toomey, CFA®, CFP®
Vice President, Research

Thursday, December 8, 2016

Research Director’s Monthly Commentary: December 2016

Biggest Money Mistakes

 Recently, a major Wall Street newspaper ran an article entitled “Biggest Money Mistakes By Decade” which caught my interest. We see big money mistakes quite often in our practice as financial planners. Money mistakes can come in many forms: poor estate planning; speculating with retirement money (e.g., day trading); taking on too much personal debt; emotionally-driven purchases, such as a big boat or second home, that are outside of one’s financial capacity; poor savings discipline; etc…the list goes on and on.
The article highlighted several “mistakes” that that I thought were noteable. One was the somewhat paradoxical mistake of “playing it safe”. One would think “playing it safe” in investing is a good thing, but from a long-term planning perspective, it can have serious negative consequences. This appears to be a problem for the younger set, millenials and GenXers. This group, which saw their parents’ portfolios crushed in the 2001 and 2008 bear markets, appear to be avoiding stocks and favoring guaranteed income. Two big problems with this strategy: 1) rates of return on guaranteed income products are now quite low implying locking in low returns; and 2) by avoiding stocks they are not capturing enough growth in their portfolios to build adequate retirement resources. The long-term rate of return on large cap stocks is about 10% per year. This is where, for most people, the bulk of their asset growth comes from. Not capturing this growth can seriously impair one’s ability to reach their retirement goal.

 The article talked about the “nightmare scenario” of having to “catch up” later in one’s life (50s and 60s)  because of a lack of retirement savings. This happens to be huge problem for my generation, the baby boomers, who adopted a “live for today” mentality. Well, the chickens have come home to roost and that mentality has led to, for many boomers, a not so happy retirement outlook and potentially a struggle in the retirement years; and social security won’t be nearly enough to offset their lifetime savings deficit. This gets back to the point of how important disciplined savings is: it pays off in the long run. For example, using current IRA contribution limits of $5500 per year up to age 49 and $6500 per year over age 50, if we assume a person averages an IRA contribution of $5500 per year for 40 years (age 25-65) growing in a diversified portfolio returning about 7% per year, this savings at age 65 amounts to $1.17 million. Not bad for $5500 per year. To avoid some form of disciplined savings is a huge money mistake.

One other mistake the article points out that can be significant for many people is the mistake of not delegating financial responsibility, particularly as one gets older, like 70s and 80s, where cognitive impairment can be a problem. I would also add to this situations where one is smart enough to know they need help… any age. For many people, to try to “wing it” on their own can lead to big financial mistakes in the areas of spending, savings, estate planning, and investments. This is where sound financial planning and working with a planner you trust can offer significant benefits. What are some of these benefits? A financial plan provides a “roadmap” that imparts discipline around the key areas of spending and savings that are critical to achieving retirement goals. A good financial plan also includes a customized investment strategy that enables the client to meet their financial objectives (retirement, estate, education, philanthropy, etc) with lower risk. Additionally, studies have shown that working with a financial planner may result in higher retirement income and a larger estate*.  Another important benefit of working with a financial planner is the peace of mind knowing you have a plan (“roadmap”) and are taking rational concrete action to improve your odds of achieving your financial goals, whatever those may be.
As we move rapidly towards year end, you may want to reflect back on 2016 and what might be your biggest money mistakes right now…..and what steps can you take now to address them.  
I wish you and yours a very happy holiday season and a happy, successful 2017 !


* “Working With An Advisor Important To Retirement Savings”, Financial Advisor Magazine, April 25, 2013


Friday, November 4, 2016

Research Director's Monthly Commentary - November 2016

Fall Foliage: Variations on a Theme

Having grown up on the northeast, the autumn season always had a special significance, not just for the pretty foliage but also as a harbinger of change. But what change you ask? Lots: the advent of snow and ski season, "fun" winter driving conditions, the end of mosquito season (!!) to name but a few.
So what does this have to do with financial planning? A lot actually. Like the changing leaves in the fall, our lives and life circumstances are constantly changing. From a financial planning perspective, changing life circumstances can (and usually do) result in changing financial prospects that in turn, raise questions about our financial goals (such as retirement, estate planning, or kids’ education goals). A change in job status or health can also result in a change in financial prospects, which can call into question one’s ability to meet financial goals.

The good news is most if not all of the financial planning issues raised by changing life circumstances can be captured in a financial plan. Our work with clients presents myriad differing life circumstances and goals. The tools we use for developing a financial plan (primarily comprehensive planning software) enables us to model a wide range of financial circumstances and goals and probability of achieving these goals. The other bit of good news about the planning process is it goes a long way to putting clients’ fears and anxieties at ease and enables them to move forward more confidently knowing a) they have a financial plan and b) doing something to take charge of their financial prospects through the discipline that a financial plan offers.

Changing prospects for the financial markets are also part of the theme of “change”. We cannot predict the short-term course of the financial markets but we know assumptions about the outlook for financial markets will change. This invariably results in market volatility, which by the way, is one constant for the markets: while we don’t know what the financial markets will do in the short term, we know there will always be volatility in the markets (and sometimes it can get severe, as in a bear market).

 Right now, based on economic fundamentals (i.e. corporate profits, inflation, etc), we think the prospects for the stock market remain favorable. One “little” issue going on now for the markets, is the upcoming presidential election. While we don’t anticipate extreme volatility regardless of who wins, there could certainly be some increased volatility associated with the outcome. We handle portfolio volatility through a) due diligence in research and securities selection in client portfolios and b) employing a diversified investment strategy. This means holding multiple asset classes (e.g. stocks, bonds, international, real estate, natural resources, etc.). Because these asset classes have varying correlations to each other, this helps to dampen portfolio volatility. So while the market may “change” through increased volatility, long-term risk-adjusted return (IMO the most important measure of performance in wealth management) should benefit through the lower volatility of an appropriately diversified portfolio.

Bob Toomey, CFA, CFP
Research Director
S.R. Schill & Associates
November 4, 2016