Monday, September 9, 2019

Research Director Monthly Commentary, September 2019

Trade News Driving Markets

A number of people have commented to me that the (stock) market “seems a little crazy lately”. Despite what may have seemed like a rather tumultuous summer for the financial markets, it really hasn’t been that bad. In fact average daily volatility has been fairly normal and the stock market measured by the S&P500 has actually logged two all time highs this year, the most recent one in July. We believe the stock market has “felt” volatile because of news flows, and more specifically, news flow around the China trade issue. A 6% decline in May and a 7% decline in early August were very average in a normal market environment and largely reflected investor sentiment driven by news flow mostly around the on-again, off-again China trade negotiations.

As of now, Wall Street has returned from summer vacation and the stock market has struck a somewhat more positive tone. A possible reason for this is trade negotiations with China are back on the table, now scheduled for October. Of course, that positive view could change with tomorrow’s tweet. But, with the admission that there is no way to forecast it, our sense is the odds are increasing that there will be some sort of agreement with China in the not too distant future, perhaps 3, 4, 5 months, which would support a stronger economic outlook. There are a couple of things that indicate the odds of a trade agreement are improving: 1) recent rhetoric on both sides appears to be a little more constructive of late and 2) both sides have increasingly important reasons to come to an agreement relatively soon.

This summer the market has also been wrestling with the implications of an inverted yield curve. Not too many people even know or care about an inverted yield curve. This phenomenon occurs when short term interest rates exceed longer-term interest rates and has been associated with recessions. We believe for a number of reasons that the recent yield curve inversion, while significant, is not an indicator of an imminent recession.

So what does this have to do with financial planning? As part of our services, we manage all or a material portion of investment assets for most of our clients. An important part of our responsibility as a fiduciary is to consider market and economic factors and to conduct research. Speaking of research, we will be holding our Q4 investment committee meeting on September 25 at which we will consider these and other issues as we set investment policy for Q4. Following the meeting, I’ll provide an update on deliberations and outlook. Looking forward, a few of the factors we believe should support a more positive tone for the stock market include:

·         Expectations for another rate cut by the Fed later this month
·         Potential for positive news regarding the China trade negotiations
·         Steady economy and consumer spending
·         Improving optimism around the corporate earnings outlook, particularly Q4.

Robert Toomey, CFP/CFA
Vice President, Research

Wednesday, July 3, 2019

Research Director Monthly Commentary-July 2019

Q3 Investment Strategy Meeting Summary

We held our third quarter investment strategy meeting on June 27, 2019. The key outcomes from this meeting included: 1) a return to a normal equity investment allocation; 2) further simplification of our fixed income holdings. A primary focus of our discussion was the China trade situation and the Trump administration’s imposition of tariffs on Chinese imports. As of now, the concerns we had about an escalation in tariffs imposed by the Trump administration have been ameliorated somewhat but not entirely. On June 29, Trump met with Chinese President Xi Jinping. The outcome of the meeting was essentially a “truce” for the time being, no additional tariffs at this time, with the intent of continuing trade discussions for some undefined duration. All of this has defused the probability of an increase in tariffs in the near term and as a result, negates somewhat our earlier concerns about the tariffs. Therefore, we lifted our equity weightings back to a more normal allocation.  

The outcome of the Chinese trade negotiations is still highly fluid and essentially impossible to predict. Our sense now is this could be a very long “battle” and the uncertainty surrounding it remains an open-ended issue for the financial markets and global economy. Recent evidence indicates the trade dispute is beginning to have an impact on global growth. This nascent global growth slowdown is having a more direct impact on emerging market economies; however, Europe is also experiencing a serious decline in its growth partly due to its higher EM exposure. All of this is weighing on investor sentiment with the U.S. now considered to be the world’s strongest and most stable economy.

With respect to the current market outlook, we continue to believe the stock market can continue in a slow “melt up” process (albeit with normal volatility)  for several reasons: 1) decent U.S. economic growth; 2) expectations for improving earnings  growth later in the year; 3) U.S. is still considered by investors the most favored region in which to invest; 4) a Federal Reserve policy that remains highly accommodative toward supporting economic growth. That said, the slowing global economy is of concern and we are monitoring this. The global slowdown appears to be affecting the industrial and transport sectors more than services; but with U.S. employment strong, we believe the consumer sector can support the economy through yet another “mini-cycle”, or mid-cycle growth “adjustment”. We expect the bond markets to remain fairly range-bound with the tendency now for further modest downward bias for interest rates.

 In terms of changes in your portfolios following our meeting, as was mentioned above, overall equity exposure was increased by about 10% to a slightly above normal weighting. This reflects above normal weightings in U.S. equities (including REITs) with international equity weightings at the lowest possible weighting. Within large cap equities, we continue to maintain specific sector exposure in health care technology and dividend growth stocks. Within developing equity, we eliminated our holding in the telecom sector and added a holding in the software and services sector as we believe software has inherently higher growth with greater stability than hardware and capital goods. Within fixed income, we eliminated our holding in floating rate debt as we believe the benefit of that will be offset by modestly declining interest rates. Finally, we set an investment “trigger” that is focused on Fed policy, namely the potential for an unexpected change in Fed policy stance away from its current  growth “accommodation” stance.

Robert Toomey, CFP/CFA
VP Research

Friday, May 24, 2019

S. R. Schill & Associates Research Commentary……

Follow Up On Our Recent Decision to Implement Our Trigger

 As you are most likely aware, on May 10 we implemented an investment strategy trigger that was set at our investment committee meeting in March. The trigger we set was to reduce our allocation to equities in the event President Trump invoked additional (25%) tariffs on imported products from China. During the week of May 6, the China trade negotiations broke down and Trump implemented the tariff increases, which caused us to implement our trigger. The investment triggers are normally set in anticipation of an event which we believe to have a low probability of occurring, but if it did occur, could have a material impact on the market and, hence, client portfolios. We set these triggers as a way to anticipate potentially negative (and sometimes positive) events and decide on a mitigation or risk-management strategy in a calm-headed way.

 So where are we now two weeks post-implementation of the trigger? Since May 10, the stock market as measured by the S&P500 is down about 2%. However, volatility has been fairly high. Technology stocks and high P/E growth stocks, particularly those with high exposure to China, have been exceptionally volatile. Additionally, there is some increasing evidence that the global economy may be slowing which raises some concern about global corporate profit growth. April U.S. durable goods orders were much weaker than expected driven primarily by lower exports implying weaker growth overseas. There has also been some increased speculation that the Federal Reserve may be growing concerned about the pace of economic growth which could lead to a Fed funds rate reduction later this year. Why might that be considered negative? In the context of a slowing economy, a fed funds rate reduction could be viewed as a negative signal for growth. We would also note that counter tariffs on goods coming from China have not yet hit U.S. companies and could pose some added risk to U.S. corporate profits.

We note that prior to the implementation of increased tariffs, the stock market made a dramatic recovery from the December 2018 lows. From the December 23 intraday low to the April 29 recovery high, the stock market gained 25%. That is about 75% on an annualized basis and is clearly not sustainable. At this point, we would not be at all surprised to see a further pullback in the stock market which would be perfectly normal as part of a normal technical “recovery” from a severe correction like we had in December (a technical recovery from a severe correction can take 3-6 months and can be volatile). Some of the factors that could cause this pullback are technical trading factors while fundamental factors could be lingering uncertainty about the trade dispute with China, concerns over a slowing global economy, or a host of geopolitical factors. The important thing to remember is your portfolios are diversified and as such, are specifically designed to be prepared for and to withstand bouts of market volatility which we know will occur periodically.

Robert Toomey, CFA/CFP
Vice President, Research

Friday, May 10, 2019

Implementing Our Current Trigger To Reduce Equity Exposure

As you are aware, at our quarterly investment strategy meetings not only do we discuss market and economic factors that might impact investment strategy, we also set triggers that require us to take some action (either buying or selling) based upon some future possible event or occurrence. This is done to allow us to set action or policy in a non-emotional or knee-jerk fashion should the event actually occur and is also a way to manage investment risk. Normally, when we set these triggers, we do not expect the event to occur or believe there is low probability of it occurring; but if it does occur, it would have a material implication for investment strategy.

At our last quarterly investment meeting on March 27, one of the triggers we set was to reduce equity exposure to the low end of the investment range in our models in the event President Trump imposed the full 25% tariffs on imports from China. As of this morning at 12:01 a.m., those 25% tariffs went into effect. We have therefore, as of this morning, reduced equity allocations in all of our models to 90% of a normal allocation and have implemented this change in your accounts as of this morning. Of note, we have only implemented (“pulled”) an action trigger perhaps once or twice before in the history of the firm, so these events are very rare.  

We had been of the belief that there would be some sort of trade agreement and still believe there very well may be one in the not too distant future. As you know, a lot of this is “posturing” on the part of both Trump and the Chinese and we believe Trump’s implementing the increased tariffs is a negotiation ploy. Both sides are engaging in negotiating ploys and neither side wants to appear weak. Our concern with the higher tariffs is that it would have a dampening effect on economic growth and therefore, it would have a negative impact on U.S. corporate profits which is the key fundamental driver of stock prices. We will be following the trade situation closely.

S.R. Schill & Associates
May 10, 2019

Friday, April 5, 2019

Research Director Monthly Comment For March/April 2019

2Q Investment Strategy Meeting Summary

We held our Q2-19 investment strategy meeting on April 2. The meeting was of particular significance for a couple of reasons: 1) update to our investment strategy, 2) important changes in how we utilize and invest our investment models (more about that later).

In terms of the investment landscape for U.S. stocks, it has improved in the past few months. Why? Largely because investors are feeling more positive about Federal Reserve policy and the prospects for some sort of trade agreement with China. As you recall, the market experienced a severe pullback in the fourth quarter of 2018 driven by concerns that Federal Reserve policy would remain too restrictive and that trade negotiations with China were falling apart. The stock market actually experienced a “bear market” (a 20% decline measured by intraday high and low) in Q4, officially marking the fourth “bear” market pullback in this cycle (which began in 2009). While your portfolio may have experienced a (temporary) decline in this market pullback, diversification of your investments across several asset classes helped to reduce the drawdown in your accounts.

So far this year, the stock market has risen about 15% and appears to be poised to reach new highs in the near term driven by improved sentiment around Fed policy, the China trade deal, and higher second half corporate profits. Our concerns in the last quarter over an inverted yield curve appeared premature; not only has the ratio we were watching (10-yr/2-yr Treasury) not yet inverted but also the yield curve (which measures interest rates along the entire maturity spectrum) appears to be steepening of late. While we believe interest rates have probably bottomed near term, we do not believe an overheating economy or Federal Reserve policy will cause rates to rise dramatically. This is supporting a positive environment for stocks and helps to support our continuing positive outlook for stocks. Short of a dramatic increase in interest rates, which we do not expect, we believe returns on bonds will remain below historic averages for the foreseeable future.

As a result of our deliberations, our overall allocation to equities increased by about 4.5% due largely to higher allocations to small cap stocks and REITs. Overall allocation to bonds increased very slightly due largely to reduced exposure to intermediate maturity bonds and increased exposure to shorter maturity bonds to capture the income potential of rising short term yields. Within equities, we continue to maintain sector investments in health care technology through IHI (iShares Medical Devices ETF), telecommunications, and medical-related real estate through our holdings of Medical Properties Trust (MPW). We put considerable effort and time in this quarter’s meeting into improving our investment model by simplification and streamlining of holdings and sector investments. We expect this effort should improve the efficacy of our investment process with the objective being improved performance in your accounts and in achieving your investment goals.

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


Wednesday, February 6, 2019

Research Director Monthly Commentary – February 2019

Volatility And Its Role in Financial Returns

What a difference a month makes ! The stock market in December (2018), as measured by the S&P500, declined 9%; the stock market in January (2019) gained 8%. Now that’s some kind of volatility! As we mentioned in previous commentaries, there were both fundamental and technical issues that generated this volatility. Quick review, the primary fundamental issues were: concerns over the trade dispute with China; concerns that the Federal Reserve was out of touch with economic reality (i.e. would go too far in raising interest rates); and concerns over global economic and corporate earnings growth. The primary technical factor affecting volatility was program (or algorithmic) trading which now accounts for up to 75% of average daily volume in the stock market. Program trading is not fundamental or fundamentally driven, but it can and does have a material short term impact on volatility.

So where are we now? In January, a number of positive things occurred: early in the month, a couple of influential Federal Reserve Board members were commenting that the Fed’s stance on rates may be too draconian; a number of large companies reported better than expected profits; and later in the month following the FOMC meeting, Fed chief Jerome Powell made comments to the effect that the Fed was materially backpedaling on its 2019 interest rate policy. This provided relief to investors who were concerned the Fed was at risk of going too far in raising rates (which it was, in our opinion). This plus scuttlebutt mid-month that trade discussions with China would/could lead to a positive outcome were enough to generate a strong rally in January. As of now, we are relatively sanguine on the stock market outlook and believe the underlying fundamentals still support higher stock prices this year. We believe the biggest near-term risk is the trade deal with China. We think the risk of a recession in 2019 is low.

But what about volatility? Certainly downside volatility like we experienced in Q4 is not pleasant. But volatility is an important component of generating higher investment returns. As investors, we have to stomach occasional periods of volatility in order to generate higher returns. If we want zero volatility in our portfolios, we can expect essentially zero or very low returns. In support of this idea, Financial Planning magazine recently ran an interesting article entitled “You Can’t Win If You Are Afraid To Lose”. The article looked at the performance of 2500 mutual funds between 1998 and 2017 in order to analyze how volatility affected returns. The article’s findings support the idea that a) higher risk (volatilty) is positively correlated with higher return; and b) the best performing portfolios experienced negative returns (down years) 25-30% of the time, or roughly 4 or 5 years out of the 20. What does this mean for us as investors? Primarily, we need to be willing to stomach occasional (downside) volatility to generate higher long-term returns. We would also add that a diversified approach to investing, such as we do here at SRS, we believe is the best way to generate higher returns with lower risk. While the inevitable periods of volatility can make us feel upset, as long we take a long-term view towards investing, avoid market timing, and invest in quality diversified portfolios, we should have a greater probability of achieving higher portfolio returns over time.

Robert Toomey, CFA/CFP
Vice President, Research

Wednesday, December 26, 2018

1Q-19 Investment Strategy Review

We held our 1Q-19 investment strategy review on December 20, 2018. At these meetings, we discuss a wide range of factors that affect the financial markets and our investment strategy. As you are aware, the stock market has exhibited above average volatility over the past couple of months and actually entered “bear market territory” this week, having declined 20.4% from the intraday high in September to the intraday low on December 24. As we have stated previously, market corrections and mild bear markets are normal occurrences in a secular bull market. We would note that during the current secular bull cycle that began in 2009, we experienced a similar mild bear market in 2011, so swings of this magnitude are not unprecedented.

We believe the primary concerns for the market now are: 1) potential for slowing global economic growth; 2) Federal Reserve monetary policy; and 3) the trade dispute with China. Additionally, the “news” environment over the past several months has been unusually active. News about topics such as trade, immigration, government shutdown, White House staff changes, etc., we believe, has added to recent volatility. Not inconsequential also has been the impact of algorithmic (or computer-driven) trading, which now accounts for a large portion of daily market volume (we have heard estimates as high as 75% of daily volume). We believe the high level of algorithmic trading is materially amplifying the recent volatility.

Currently we believe the market appears to be disconnecting from the economic fundamentals. With respect to the global economy, we believe there will be some slowing in U.S. and global growth in 2019 but we believe it will still show good growth with the U.S. GDP now expected to grow about 2.5%. With regard to Fed policy, the Fed recently signaled it will most likely reduce the number of rate increases it expects in 2019 from four increases to two. This is a positive development and sends the message that the Fed is maintaining flexibility with regard to its policies. With respect to the China trade dispute, there appears to be some behind-the-scenes progress but it will take more time to see if the dialogue proves successful.

Let’s not forget there are some positives right now, to name a few: 1) Federal Reserve policy appears to have become a bit less aggressive; 2) investor sentiment has turned quite bearish; 3) valuations for stocks have declined significantly to about 14.5x forward P/E estimates and we believe there should be decent fundamental support for stocks at a forward valuation in the range of 13-14x; 4) based on the earnings yield, stocks still remain attractively valued relative to bonds.

With respect to changes in your portfolio, one of the key things to come out of the meeting was a review of all holdings which resulted in a reduction in the number of holdings in your portfolios. Within equities, our deliberations resulted in a slight 3.5% reduction in equity allocation while allocation to bonds remained the same. We again slightly increased our weightings in “value” stocks within both U.S. large cap and international equities. We maintained our sector investments in medical equipment and telecom stocks and added a small position in gold as a hedge against market volatility. Within the bond area, we continue to maintain a heavier weighting toward shorter duration bonds. We also changed our core bond holdings to U.S. Treasury bonds from U.S. corporate bonds as we believe Treasuries offer great stability in what we expect may be a more volatile market environment in 2019.

We want to emphasize that your portfolios are diversified across nine asset classes and that U.S. stocks are only a portion of your total holdings.  This is done primarily to reduce portfolio volatility particularly during times of above average market volatility. We don’t believe in timing the market; but rather, we believe remaining disciplined to an appropriate portfolio allocation along with some tactical allocation is the best way to provide long-term asset growth with lower volatility and higher risk-adjusted returns.

Robert Toomey, CFA/CFP
Vice President, Research