Research Director's Monthly Commentary: Review of Q3 Investment Strategy Meeting

We held our third quarter investment strategy meeting on June 24, 2016. It was a particularly interesting day in that it was the day following the “Brexit” vote. The fact that UK voted to leave the EU came as a surprise to investors and financial markets reacted accordingly. The Brexit and its implications made up a large portion of our discussion at the meeting. We consider the 5% U.S. market pullback following the vote by no means a “panic” but more a normal reaction to a new uncertainty. At this point, it could be many months before anything actually happens from this vote and how this all plays out remains to be seen. This maintains the element of uncertainty which can be destabilizing to the financial markets.

 

Prior to June 23 vote, our feeling had been that the economy and corporate earnings were poised for modest acceleration in the second half of 2016 and 2017. Following the Brexit vote our view on the U.S. economy has not changed materially, although the rate of growth we had previously expected of about 2.5% could be impacted slightly, perhaps 0.2-0.4%; we don’t see it resulting in a recession. We believe Brexit will have a more palpable impact on Europe as it sorts out trade and monetary treaties. This could impact the flow of trade and currency in that region and it is not out of the question that Europe could experience a mild or moderate recession as it goes through this period of adjustment. This could potentially have further negative effect on the financial markets.

 

With respect to interest rates, we believe rates will most likely decline over the near term as investors seek a “safe haven” in quality government securities, such as U.S. Treasury bonds. We also believe any rate hike by the Federal Reserve will now most likely be postponed into 2017. U.S. stocks should most likely continue to be viewed as a “safe haven” and this could eventually prove positive for U.S. stocks as well as bonds.

 

Following our meeting, we have taken proactive measures to increase portfolio stability in what we believe could be a period of elevated market volatility. We slightly reduced overall investment exposure in order to increase cash. Within large cap equities, we added a position in U.S. consumer staples (XLP) as we believe this sector offers stable earnings and rising dividends with below average volatility. We also added a position in utilities as this group has also exhibited lower volatility while providing a stable income stream. Within natural resources, we moved to represent this sector entirely with gold through purchase of the IAU gold ETF. Gold has historically acted as a good hedge during periods of heightened financial market volatility. Within fixed income, there were no significant changes and we continue to hold neutral weightings across all three maturity sectors. We also set in place a trigger that would require us to take defensive action if the yield on the 10-Year U.S. Treasury bond falls below 1.0%.  You can hear more about these changes by viewing our third quarter-2016 investment meeting video on our website at www.srchill.com.

 

Research Director’s Monthly Commentary - May 2016

 The Beatles and Financial Planning

 

My favorite group growing up was The Beatles. I remember listening to (and loving) so many of their songs. Thinking back, it occurred to me The Beatles wrote a few tunes about the topic of “money”. See, you thought The Beatles had nothing to say about financial planning and this would be a corny article. In fact, they said a lot about the topic.

 

“Money can’t get everything, it’s true, but what it don’t get I can’t use”…..is a famous line from the song “Money”, a Beatles cover written by Barrett Strong. So while it is true that money can’t buy everything, good financial planning and sound investing can help what you have go further and improve your lifetime financial security. In fact, a study done a couple of years ago found that people who work with a financial planner significantly improved the odds of achieving higher income during retirement, potentially by as much as 40% higher income*. Doing a financial plan has many benefits including better organization of your financial affairs, better discipline and goals for savings, and a disciplined investment strategy. All of these factors play an important role in improving the odds of financial success and greater lifetime financial security.

 

“Taxman”, written by George, is a searing criticism of the tax system in England in the 1960s (in which the top rate could reach 98%). Fortunately for us in the U.S., we do not have to face tax rates they did in England in the 1960s. But taxes are very important from a financial planning standpoint. Good tax management can have a significant impact on one’s life savings and the success or failure of a financial plan. A comprehensive tax analysis is an integral part of any financial plan we do for a client. A thorough tax analysis provides us and the client with ideas and avenues for reducing taxes or pursuing strategies that may preserve capital in an estate.  

“When I’m Sixty Four” was a fun, (obviously) McCartney tune written about an idealistic retirement some 40 years hence. Most people hold an idealistic vision for a comfortable retirement. Financial planning can greatly improve the odds of achieving a comfortable retirement. By analyzing one’s expenses, income prospects, assets, and financial goals, we create plans/projections that provide clients with a much clearer vision and improved probability of achieving those goals. Like the song implies, it has to do with looking forward in many cases multiple decades. The process best starts in the 30s and 40s and goes a long way in improving the odds of having more “money” in retirement and greater peace of mind knowing one has a plan to improve the odds.

 

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

Research Director’s Monthly Commentary - April 2016

Industrial Metals A Leading Indicator?

 Wow, what a difference a month makes! Well, maybe two months. As of today, the stock market is up 15.7% from the February 11 low, a surprisingly strong rebound in a short period. Looking back at the fundamental data earlier in the year, we were perplexed why the market sold off so sharply as there seemed to be no significant changes in economic fundamentals that would warrant such a sell off. Investors now appear to be more sanguine about the outlook for the global economy and the risk of a global deflationary spiral. The Federal Reserve recently reiterated its stance on taking a very gradual approach in raising interest rates, and recent data out of China indicate the measures it is taking to shore up growth could be more effective. All that makes investors happy and more willing to put money into stocks.

 

  From a sector perspective, it is interesting that cyclical and industrial stocks have been leading the charge on the upside in this recent rally. For example, industrial metals stocks (copper, steel, aluminum, nickel) have been vastly outperforming the broad indexes as reflected in the XME, the S&P500 metals and mining ETF, which is up 59% since the February 11 low. Historically, rising industrial metals prices have been an early indicator of an improving economy and we think the strong move in the XME may be telling us that economic growth may be poised to accelerate. The strong move in this ETF has also been accompanied by significant weakness in the U.S. dollar, rising oil prices, and a jump in international freight rates. All these indicators look similar to what one might observe coming out of a recession. I think it is safe to say that the oil industry and certain industrial sectors have gone through a recession over the past year. We saw something like this, although more severe, in the early 1980s just before the stock market entered a strong bull market that lasted five years. Could this happen again? Quite possibly, as we believe the U.S. stock market remains in a secular bull market (i.e. a bull market lasting on average 15-20 years).

  

So what does this have to do with financial planning? From our perspective, it is an important element of the work we do for our clients in helping them achieve the objectives of their financial plans. Our investment committee considers fundamental and economic factors every quarter when we assess the investment allocations and securities holdings within our client accounts. At our most recent investment strategy meeting at the end of March, we added a position in the XME within our natural resource holdings because we felt if offered a way to enhance the growth of our clients’ assets. In previous quarters, we’ve done this in other sectors such as health care, technology, forest products, and housing. If we identify a sector that we believe offers significant value, as we do with XME, we can find ways to add that within our diversified structure to enhance returns to clients and enhance the overall value we bring to our clients.

 

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

Q2 Investment Strategy Update

We held our second quarter investment strategy meeting on March 22, 2016. At this meeting we deliberate and discuss various economic, market, and financial factors that influence our strategy for investing your assets. From this deliberation we set our investment policy and implement the policy through changes in holdings in your portfolio.

Right now the pace of global growth continues to remain sluggish due primarily to slowing growth in China, slow growth in Europe, and recessionary conditions in many emerging market countries. The U.S. remains one of the strongest of the major global economies growing at a pace of 2-2.5%. Slow global growth combined with a strong dollar has negatively impacted U.S. corporate earnings growth over the past few quarters which has been a hindrance for the U.S. stock market and a contributing factor to the recent market correction. The good news is the U.S. market appears to be recovering from its recent correction (now up 12% since the mid-February low) due to improving investor sentiment towards the U.S. economy. The outlook for both European and emerging market economies remains poor at this point.

The Federal Reserve came out with surprisingly dovish commentary following the March FOMC meeting. The Fed held off on a second Fed funds rate increase we believe due to concerns about slow global economic growth and disrupting other global monetary policy activity, particularly Europe, which is experimenting with negative interest rates to stimulate bank lending. While we expect the Fed may raise rates one or two more times this year, we would not expect these rate increases to derail the secular bull market in stocks as long as inflation remains moderate (which we expect) and economic growth continues at a moderate pace.

With respect to changes resulting from our meeting, the most significant change was our increase in weightings in value stocks. We did this across all equity categories because a) value stocks have underperformed growth stocks for a considerable period and therefore offer opportunity; and b) if corporate profit growth remains subdued, value stocks should have a greater opportunity for valuation improvement relative to growth stocks which are currently richly valued. The increased emphasis on value actually increased our overall equity exposure by about 2%.

Other significant changes following the meeting include slight increase in our weightings in natural resources/commodities including a new position in industrial metals (XME). We think industrial commodities offer value because of the severe decline they experienced over the past year as a result of concerns over a global recession. With respect to fixed income, there were no significant changes. We slightly reduced our weighting in both the long and short end of the yield curve. We remain essentially neutral in both the long and intermediate portion of the yield curve and overweight the short end. We continue to utilize corporate bonds for fixed income exposure due to their higher coupon yield and higher income to your portfolio.

3-24-16

 

Research Director Monthly Commentary: February 2016

What if there is a recession?

 There has been a lot of talk in the financial news media in the past few weeks about increasing probability of a recession in the U.S. Citigroup was out recently with an alarming report that, in their view, the risks of a global recession have increased materially. The primary reason they cite is concern that U.S. economic growth is slowing and because of that, the risk of recession has increased. Another argument for supporting the idea of recession focuses on U.S. corporate earnings growth, which has been negative for the past several quarters, and declining corporate profits have led to recessions in the past.

There is no question that concerns over a recession have added to market volatility this year. Market volatility has been further exacerbated by concerns over slowing growth in China, plummeting oil prices, and a change in Federal Reserve policy. But what is the real risk of a recession actually occurring?

 Recent growth in the U.S. measured by GDP has been slow, to wit Q4-15 real GDP growth of about 1%. We have to remember that the recent decline in oil prices and oil-related activity has had a material impact on the economy. Also, the theory that negative corporate profit growth will lead to recession also has to be put into context: if one excludes the energy sector from S&P500, corporate profit growth was a reasonable 5% in 2015 and is expected to be about that level in 2016. Employment in the U.S. remains stable and reasonably healthy and unemployment claims continue to decline. Housing remains strong and growth in consumer spending is also expected to remain healthy in 2016 at about 3%. The point is there is very little evidence aside from earnings, that the U.S. is on the verge of recession. The concern over the strength of the Chinese economy also appears to be misplaced: U.S. exports to China represent a very small 1% of GDP; and Barron’s magazine recently cited economist Michael Lewis who found that not a single recession in the post-World War 2 economy could be traced to foreign economic woes.

 
So what is the point of all this? 1) We think concerns over a U.S. recession are overblown; and 2) even if there is a recession, we know that that are ways to position portfolios to reduce the impact of a recession. What are some of those ways? Diversification by asset class can help to reduce portfolio volatility because of differing correlations of returns. For older clients who cannot withstand higher volatility, allocations can be more skewed towards fixed income investments which have a low or negative correlation with stocks. Through tactical asset strategies, investment managers can reduce overall equity exposure in a client portfolio or increase holdings in sectors with lower volatility (such as utilities or consumer staples).  In other words, there are ways to mitigate the risk of recession through proactive risk management, with the classic strategy in this regard being asset class diversification, and maintaining a financial plan that not only includes an appropriate investment strategy but also reduces the temptation to time the market by imparting investment discipline. Clients will be better positioned to weather a potential recession if their portfolios are properly positioned in accordance with a sound financial plan.

 

Research Director Monthly Commentary: January 2016

Deep Powder

 

Over New Year’s I was skiing with my family in the Washington Cascades in some of the best snow conditions I can ever remember: 170 inches of deep, soft powder….so deep you could stick your ski pole into the snow and it would not stop going down…down. As you might imagine, ski conditions were fantastic.  

We did some off trail skiing into what some might refer to as “backcountry”. To get there, we had to traverse through forested areas with cliffs, shelfs, and drop offs. One thing that occurred me trekking out in this was the “problem” one might have if one “slid” off the trail and head-planted into this deep, deep powder…..it could be potentially deadly because it would be so hard to get out of on your own.

So what does this have to do with financial planning? Two words: “risk management”.  Just as in investing, off-trail skiing has certain risks you don’t find when skiing the “groomers”. Risks include getting lost, getting injured far from help, hidden obstacles under the snow like rocks and fallen trees, or ironically, snow that is SO beautiful it has a seductive charm that can lead to a problem, such as a deep fall from which extraction is quite difficult.

We can take precautions to manage risk while skiing in the backcountry that improve our odds of success: don’t ski alone; carry a GPS device; carry safety equipment that may help you “dig out”; if you don’t know the area, go with someone who does; and most of all, know your limitations and abilities.  

Just as in backcountry skiing, there are precautions we can take to manage personal financial risk through financial planning.  One element of this involves preparation. Preparation comes in the form of information gathering, organizing one’s financial affairs, and setting goals as part of a plan. A good financial plan provides discipline which helps reduce risk by adhering to the goals of the plan, such as budgeting or savings goals, tax or estate goals, and discipline in investing. A formal investment plan, and the discipline to stick with the plan for the long term, can significantly improve the likelihood of achieving your financial goals.

Having a sound financial plan is like skiing on a trail you know is secure, it provides a rational roadmap to keep you on course with your financial and life goals and reduces the risk of a “headplant”. It’s also about knowing what you don’t know….if you are skiing backcountry, it is important to know about snow conditions, terrain, or how to find your way back down safely. The analogy to financial planning is guessing or not knowing if your financial plan is appropriate can increase personal financial risks and cause one to fall short of his/her goals. And it is important to be honest with yourself: if you truly do not understand your financial roadmap or how your investments can work better for you, seek the counsel of an advisor you trust.

Bob Toomey

Research Director

S.R. Schill & Associates

Summary of our 1Q-16 Investment Strategy Meeting

We held our first quarter investment strategy meeting on December 22, 2015. From a longer-term perspective, we continue to believe the U.S. stock market remains in a secular bull market. That said, within secular bull markets there will inevitably be periods of volatility, corrections and cyclical bear markets. Our strategy of investing your capital in a diversified portfolio helps to mitigate exposure to market volatility.

While the stock market delivered  (up to now) a flat performance in 2015, we think a number of the issues contributing to that performance, such as the decline in oil prices, weaker nominal earnings, and uncertainty over Federal Reserve policy, are being resolved. The Federal Reserve finally raised its benchmark Fed funds rate on December 16. This action removes an element of uncertainty which overhung the market for many months. Also U.S. corporate profits declined in 2015 due to low oil prices, weaker exports, and the strong dollar. With the U.S. economy on firm footing (we expect real GDP growth of around 2.5% in 2016), and oil prices most likely in a bottoming process, this should contribute to improved corporate earnings visibility in 2016.
 

There are lingering issues in 2016, such as the strong dollar and slower growth in China and emerging markets, that will act as a drag on both global GDP and U.S. earnings; however, with the U.S. economy now delivering the strongest growth of developed world economies, we believe U.S. stocks will continue to be viewed as attractive. We also believe the pace of future rate increases by the Fed will be very gradual. This combined with moderate improvement in corporate earnings growth should help support stock valuations as we move through 2016. As we’ve said before, we believe stock market returns going forward will be lower than the mid-teens growth experienced over the past 5-6 years largely due to maturation of the economic cycle and slow global growth. We expect U.S. stock market returns going forward will more likely be in the 5-10% range.

With respect to significant changes in your portfolio following our meeting, we continued to increase our weighting in U.S. large and mid-cap growth stocks. We believe growth stocks that deliver higher earnings and cash flow growth will garner higher valuations in a slow or moderate growth environment. We also slightly reduced our exposure to international equities due to lower expected growth compared to the U.S. Within fixed income we slightly raised both long end and short end exposure. While we expect long rates to remain relatively flat even with the Fed gradually raising rates, long bonds provide a higher level of income in your portfolio. We expect short debt exposure can benefit more from a gradual rise in short-term rates thereby providing potential for growth in portfolio income.