Friday, December 7, 2018

Comments on Recent Market Action

It has not gone unnoticed by us that it has been a rather tumultuous week for the stock market. We have a few thoughts on this that we’d like to share. What seems to be bothering investors most of all now, among an array of factors, is uncertainty over three things: Federal Reserve policy, the U.S.-China trade situation, and (near) inversion of the Treasury bond yield curve that many believe presages a recession. Add to this the impact of algorithmic (computer-driven) trading, and it all adds up to heightened market volatility.

With respect to the above-mentioned concerns, we offer the following thoughts: 1) We believe the probability is increasing that the Fed will materially curtail interest rate hikes in 2019, which should be positive for financial assets. 2) We believe there is a reasonably good chance there will be some positive progress made within the next 90 days on the U.S.-China trade dispute. 3) We believe the concerns over the yield curve possibly inverting may be overdone, but we are watching this. You might recall, we did set an action trigger at our September investment meeting which would cause us to take some protective action in the event the trigger is breached. The trigger is an inversion of the Treasury yield curve (meaning the spread between the yield on the 10-year and 2-year Treasury bond goes negative). As of today’s close this spread is positive, so it has not yet inverted, but we believe investors are concerned or projecting that it will invert.

The bottom line is the market is dealing with a little more uncertainty at the moment. As we stated in our previous commentary, we expect market volatility to remain elevated for a while longer, perhaps into early next year and we would not be surprised to see the stock market go a bit lower as part of a normal corrective process. As we move forward, there are a few key things we want to stress: 1) We have been through this before and corrections (and even mild bear markets) are normal parts of a secular bull market cycle. 2) Your financial plan and investment strategy take market volatility into account. We have selected a customized strategy for you that is diversified across nine asset classes. Only a portion of your assets are in U.S. stocks. The diversification of your portfolio is designed to dampen volatility. 3) We remain confident in the long-term strength and resilience of both the U.S. economy and the stock market and we do not believe there is a need at this time for any unusual or drastic action related to portfolio or investment strategy.

As always, if you have questions or concerns, please contact us.

S.R. Schill & Associates

December 7, 2018




Tuesday, November 20, 2018

Research Director Monthly Commentary, November 2018

Not A “Systematic” Correction

 Deep breath……aaahhh. As we’ve stated in the past, market corrections are normal and occur often. Looking back on the last 90 years, on average, corrections occur about once a year (we have been well below this average in the current 9-year bull cycle); the average correction is about 13% in magnitude (we are down about 10%); the average consolidation process following a correction lasts about 3-4 months (we are less than one month past the October 29 low).

We believe the current correction in stocks is due to a combination of factors, but primary among those are a valuation adjustment in tech stocks and concerns over the Federal Reserve getting too aggressive with raising interest rates. Secondarily, but also significant, have been concerns over the U.S. trade dispute with China and federal government policy uncertainty looking into 2019. The bulk of the correction has occurred in a fairly narrow area of the market, primarily the technology and energy sectors, so it does not appear “systematic”. Many sectors have held up well and the fact that the correction is fairly narrow in scope, at least up to now, is quite possibly a signal that this pullback is not something more serious. We also believe much of the selling is institutionally driven (hedge funds, bank trading desks, and computer-driven trading) which can  add significantly to intraday volatility. Algorithmic (computer-driven) trading is detached from fundamental investing and has led to greater market volatility.

As of now, the stock market as measured by the S&P500 is down about 10% from the September 20 all-time high, well within the bounds of a normal correction (a correction is defined as a pullback of 10-20%). We would not be at all surprised to see the market re-test the 2550 February and April lows, or even go a bit lower. This would be a normal technical re-test in a bottoming process. That said, we cannot, nor can anyone for that matter, forecast what the market will do in the short term. You will recall that we did take some steps to de-risk portfolios following our September 27 investment strategy meeting due to concerns primarily with tech stock valuations. We remain positive on the longer-term outlook for U.S. stocks, although we expect market volatility could remain elevated for a while longer. Looking into 2019, we believe the U.S. economy should remain healthy, corporate profits should grow in the range of 5-8%, inflation should remain moderate at around 2-2.3%%, and the Fed should move to a less hawkish stance on interest rates. One concern is the outcome of the trade dispute with China. We should have greater clarity on that after the G-20 summit in two weeks.

So what does this have to do with financial planning? Financial planning helps mitigate risk in a number of ways. It helps people identify and address personal financial risks. It helps people organize and better define their finances and financial goals. It also helps set an appropriate investment strategy. An appropriate investment strategy, which includes an appropriate allocation across several asset classes, helps to mitigate volatility and has shown to improve risk-adjusted returns. An example of how diversification benefits your portfolios is, over the past two months while the S&P500 is down about 10%, your short and intermediate term bond holdings have barely budged in price. Investment allocations should be set within the discipline of a financial plan in a rational and non-emotional way. Making sure your financial plan is up to date and re-balancing your portfolio to an appropriate allocation will go a long way towards helping to reduce risk and allowing one to sleep better during inevitable bouts of market volatility.

From all of us at S. R. Schill, have a very happy Thanksgiving !

Bob Toomey, CFA/CFP
Vice President, Research

Friday, September 28, 2018

Research Director Monthly Commentary: September 2018

Q4 Investment Committee Meeting Review

We held our Q4-2018 investment committee meeting on September 27. The key take-aways from the meeting are:  1) we continue to have a positive view towards equities; 2) we took some steps to modestly de-risk our U.S. equity exposure; and 3) our stance towards fixed income holdings remains unchanged.

The macro context for equities continues to remain positive due to a strong U.S. economy and continued strong corporate profit growth. The U.S. economy is showing broad-based strength across virtually all sectors. Consumer and business confidence remains strong and is driving healthy spending in those sectors. Employment is strong. Manufacturing is healthy reflected in rising orders and production and strong corporate cash flows are getting recycled into the economy by way of increased hiring and capital spending. We believe this bodes well for continued economic expansion. While the trade tariff issue continues to be a concern, the quantifiable impact of tariffs on the economy are modest and very small in actual dollar terms relative to total U.S. trade volume.

With respect the Federal Reserve’s recent increase in the Fed funds rate, this was expected and does not alter our assessment of Fed policy which remains essentially unchanged. At this point, Fed policy continues to remain gradualist and accommodative to the financial markets. At some point this may change, but we believe it is a ways off, especially if inflation remains low to moderate. We expect there will be some increase in inflation over the next year but we believe it will remain modest, perhaps 2.2-2.5%, and certainly not 1970s-style inflation. Low inflation should allow the Fed to remain gradualist in its policy and thereby should not be overly disruptive to the financial markets, at least near term.

On a relative basis, we still believe U.S. equities remain the most attractive of the major developed markets and we therefore continue to overweight our U.S. equity exposure and underweight international. While the U.S. economy is clearly in the most stable condition of major world economies, of late emerging market economies have suffered due to uncertainties surrounding the trade tariff issue.  The Eurozone economies continue to plod along at modest 2% growth and we do not see much upside to Eurozone growth.

We have become somewhat more concerned of late about stock valuation. Valuation is “high” by a number of measures. While a high valuation does not imply an imminent decline or rollover in the market, we believe it is prudent, given our concern, to address valuation risk in your portfolios. A couple of the steps we are taking this quarter to mitigate valuation risk include: 1) increasing weightings toward value stocks; 2) adding a position in the U.S. telecom sector ETF (IYZ) which we believe offers lower valuation and reasonable risk/reward. Taken together we believe these actions place more of your equity investments into sectors that offer lower valuations and lower downside risk in the event of a market decline. Within commodities, we added an investment in the metals and mining sector (XME) as an inflation hedge. Overall, our equity exposure was reduced very slightly. There were no changes in our bond holdings nor were there any significant changes in weightings within the three fixed income sectors. We expect interest rates will continue to rise gradually and we therefore continue to maintain the lowest possible exposure to long bonds while keeping overall bond duration at the low end.

Robert Toomey, CFA, CFP
Vice President, Research

Tuesday, July 31, 2018

Research Director Monthly Commentary for July/August

Time to Play Defense?

The stock market appears to be in a now familiar “recovery” pattern from the 12% correction it underwent in the January-April period of this year. As corrections go, 12% is “run of the mill”, about in line with the historic average for corrections of 13.3% decline. As we have said before, corrections such as this are quite normal and are, in fact, healthy for the market because they help to temper market excesses.  

Currently, there are some interesting internal dynamics going on in the stock market: hyper-growth stocks (or “FANG” such as Facebook, Apple, Netflix, Google) appear to be taking a breather after carrying the market for some time, in fact years. Some market pundits are of the opinion that if these hyper-growth stocks falter, it is a bad sign for the market. We disagree for several reasons: 1) there are many other sectors of the market, particularly industrial, financial and energy sectors, that have underperformed and we believe may be in a better position to take over market leadership; 2) we believe many of the hyper-growth stocks have strong long-term fundamentals and while as a group, could underperform for a period, they ultimately have superior long-term growth prospects which should help support their valuations (and stock prices) over time.

The bond market is currently in a defensive mode due to rising interest rates. Bond prices move inversely with interest rates and we expect the bond market to remain in a defensive mode for some time, thereby keeping total returns for bonds below the long term averages. We still need and use bonds for diversification purposes because bonds prices have historically risen when stocks decline, particularly in a bear markets. That said, we do expect returns on bonds to be below the long-term averages for the foreseeable future.

Do we see now as time to get defensive on equities? The answer is no. Underlying economic fundamentals remain excellent: employment is strong; workers’ incomes are rising; consumer and capital spending remain strong; and the tail winds of lower corporate tax rates and immediate expensing of capital investments should all help to sustain the current economic recovery much longer than many pundits currently project. All of this positive for corporate profits, which are the primary driver of stock prices. And with respect to concerns about the much-discussed Fed raising interest rates, we fully expect this will continue; however, we see it 1) as a positive because it is helping to normalize interest rates; 2) we believe the Fed will not accelerate rate increases; 3) the rate increases are sign of a healthy economy; 4) the Fed Funds rate is still well below the historic relationship to nominal GDP, which means monetary conditions are still no where near “tight”.

Concept of “inherent defense”………..So does this market analysis matter to your portfolio? Yes, primarily in the sense that as fiduciaries and managers of your money, we need to remain vigilant in monitoring market fundamentals as it pertains to investment strategy. But remember that your portfolio is diversified across nine asset classes, including three in equities and three in bonds. Holding multiple asset classes helps to mitigate portfolio volatility and deliver higher risk-adjusted returns. In addition, your portfolio is allocated across these nine asset classes in a way that provides necessary growth for your financial plan strategy while keeping risk to a minimum; in other words, if your financial plan shows that you can achieve your goal with a less aggressive allocation, we believe it is prudent to invest in the less aggressive allocation in order to mitigate portfolio volatility.

So, while we may not believe it is “time to play defense” with respect to equities, remember that our strategy of allocated portfolios, “due diligence” in the form of our quarterly investment strategy meetings, and quarterly rebalancing all act to provide a level of “inherent defense” in your portfolio that should help to mitigate risk and volatility when markets do become more turbulent.
Bob Toomey,
Vice President, Research




Monday, July 2, 2018

Q3 Investment Meeting Summary

We held our Q3 investment strategy meeting on June 27, 2018. At our meeting we were fortunate to have a prominent local bond portfolio manager, Dean Amundson, join us. Dean’s knowledge and experience provided us with extremely helpful insights into the current bond market.

One concern that has increased within the bond area is the flattening of the term structure of interest rates (also known as the “yield curve”) which has been occurring as the Federal Reserve raises its short-term inter-bank lending rate (the Fed funds rate). The concern is that if the Fed pushes this rate much above the yield on the 5 or 10 year Treasury note (now at 2.53% and 2.85%, respectively), it could create what is known as an inverted yield curve. An inverted yield curve has historically been associated with or preceded the last seven U.S. recessions, so a flattening yield curve raises alarm bells among stock investors.

We think the concerns over the flattening of the curve may be premature. There are several reasons for our thinking; 1) we think the Fed will be very reluctant to cause a yield curve inversion; 2) over time, higher growth rates and inflation expectations should result in some increase in long-term bond yields; 3) we believe the economy can function normally even if the yield curve remains flattish (but not inverted), i.e., a flattish yield curve should not necessarily constrain access to capital or shut down bank lending.

Given the fixed income background, we think equities can still do well as long as inflation remains moderate, which we expect, and corporate cash flow growth remains strong, which we also expect. One concern is that equity valuations may have peaked (the “as good as it gets” argument). We think there is room for further improvement in valuation based on what we believe will be 1) a longer-than-expected economic cycle thereby 2) supporting a sustained higher level of corporate cash flows. We expect stronger sustained corporate cash flows should result in rising dividends and share buy-backs, which increase the attractiveness of stocks.

With respect to changes in our investment models (and your holdings), we slightly reduced our allocation to equities primarily through moving to a slight underweight in international stocks from a previous overweight position. Within both U.S. and international equities, we continue to maintain a relatively balanced allocation to both value and growth. We continue to maintain targeted sector investments in three areas:  financial (XLF), health care (IHI), and the U.S. housing sector (ITB). We believe all three sectors still offer attractive growth potential. Within bonds, we continue to maintain our lowest possible allocation to long bonds and continue an overweight in short-maturity bonds as we believe this sector should actually benefit as short-term rates rise. Within intermediate bonds, we added a position in shorter-maturity floating rate bonds in order to further reduce overall duration of your bond holdings and thereby help to reduce portfolio volatility.

Have a happy and safe 4th of July holiday !

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




Thursday, June 14, 2018

Research Director Monthly Commentary: June 2018

The Fed: More Goldilocks

While it may seem boring, this is important from the standpoint of your investment portfolio: yesterday, as expected, the Federal Reserve raised its Federal funds (overnight interbank lending) target rate range by 25 basis points to 1.75-2.00%. The importance is not so much the rate itself (still highly accommodative) but rather the outlook commentary and posture of the Fed’s economic viewpoint. The viewpoint appears to continue to support a “goldilocks” environment for stocks.

The Fed’s commentary following its FOMC meetings is sliced and diced six ways to Sunday by the media and investment industry pundits. Our take on the Fed’s commentary is pretty straightforward: 1) the Fed is essentially saying that the economy is looking very good; 2) inflation and inflation expectations remain stable and moderate, around 2%; 3) there is no change in the Fed’s interest rate policy, which is continued steady quarterly increases in the Fed funds rate: two more this year and probably three more next year. We believe this outlook is actually quite positive (almost “goldilocks”-ish) for stocks because it indicates the Fed, in both its actions and outlook, remains committed to providing a monetary backdrop that is conducive to economic growth which, in turn, is supportive of corporate profit growth, the single most important driver of stock prices.

Some pundits have raised alarm bells that the Fed rate policy ultimately sets the stage for inverting the yield curve and tipping the economy into a recession. These same pundits take a guess at when the next recession starts, and some of them are now saying 2020. While pundits are paid to write and stay stuff that sounds smart (and granted many of them are smart), we respectfully submit that not only is it difficult to forecast a recession, but also we believe the current expansion could be surprisingly durable and last longer than many now expect. Our reasoning? Currently there do not appear to be major economic or financial imbalances that usually precede an economic downturn. Inflation continues to remain moderate. Fed policy remains accommodative. The corporate profit outlook remains healthy. Valuations based on forward P/E are not exceedingly high at 17x.  

So what does this have to do with financial planning? We, as a fiduciary to our clients, need to have a framework for setting investment policy. Along with factors such as the economy, inflation, corporate profits, valuation, and geopolitical risks, Fed policy is a critical element in assessing the investment environment. Based on these factors, we still believe the outlook for stocks remains quite positive and this gets reflected in our allocation to equities, which we are currently overweighting in our strategies . While the risks of a trade war have been prominent in the news of late, at this point, we still believe the risk of an all-out damaging trade war remains low. We will be holding our Q3 investment strategy meeting on June 27 and will have a further update on our investment strategy at that time.

Robert Toomey, CFA/CFP
Vice President, Research



Monday, May 7, 2018

Research Director Monthly Commentary: May 2018

More On Volatility
As we mentioned in our March comment, we expected stock market volatility to increase this year and it  has. The low volatility experienced in 2016 and 2017 lulled many investors into believing low vol was here to stay. This was not to be the case, nor could it be. Market “corrections” (downward moves of 10%-20%) have historically occurred on average about once a year, while market “adjustments” (downward moves of 5-10%), have historically occurred about 3 times a year. To not have not a downward move of even 5% for a period of about 21 months (March 2016 to December  2017) was not only a record, but entirely unsustainable. 

What has contributed to the increased volatility this year? Several factors: concerns over Federal Reserve policy, concerns over rising inflation, concerns over the potential for a trade war with China, and more recently, increased legal troubles for President Trump. We believe the concerns over Fed policy and inflation have been overblown. The Fed continues to maintain a steady and well telegraphed interest rate policy and, absent a dramatic acceleration in inflation (which we do not expect), we believe Fed policy should not lead to damagingly high interest rates. With regard to inflation, we had some good news in the April payroll report in which the pace of both job creation and wage growth cooled off from previous readings. Wage growth of 2.6% is in line with the long-term pace during this recovery and we believe does not have inflationary implications, at least as of now.

With respect to the potential of a trade war with China, we believe investor concerns over this issue are justified; however, we believe a more probable outcome is that China and U.S. will ultimately reach some reasonable and mutually accommodative position. We believe China understands there has to be more of a balance in trade with the U.S. to sustain a positive long-term relationship and access to vital U.S. markets. With respect to Donald Trump’s legal problems, it is difficult if not impossible now to predict an outcome or ending for this. Uncertainty around any country’s executive leader is problematic for the market and we expect this issue could continue to contribute to market volatility in the near term.

What’ the point? So the point about this rather dry analysis is to put recent stock market volatility into context. We have heard some concerns from clients about the recent volatility. We want to assure clients that a) volatility is normal, b) we understand what is causing it, and c) we believe underlying economic fundamentals remain favorable for stocks. We often get the question “should I pull my money out til this is over?”….. in other words, try to time the market? We have long understood, and studies show, that market timing is difficult if not impossible. One interesting statistic on this: according to BTN Research, the total return for the S&P500 over the past 10 years has been 8.5% per year. If you missed the 10 best percentage gain days over this period, the return drops to an annual gain of 1.3%. There will be periods of variability, some more violent than others. Trying to time the ups and downs of the market will almost always lead to disappointment and lower long-term returns. With regard to investing, it is important to keep volatility in context, maintain a long-term view, and adhere to a disciplined investment process.

Despite the recent volatility, we remain constructive on stocks. Valuations based on forward price/earnings for stocks remain reasonable and about in line with the long-term average (about 16x), so stocks are not overvalued. Valuation is the single most important factor in determining long-term stock returns. While there is some concern about a peaking in earnings growth in 2018 (also contributing to recent volatility), we believe it is likely that even if earnings growth slows, which it will, corporate cash flows should increase significantly in 2018 and 2019 as a result of the tax bill. As corporations return this cash to shareholders, we expect a lot of it will get “recycled” into the stock market, thereby providing fuel for higher valuations and stock prices over time. Another way of looking at it is we expect investors most likely would pay up for stronger and perceived sustainable cash flow.

Robert Toomey, CFA/CFP
Vice President, Research