Summary of Our Deliberations

On Monday March 23, 2020, we held the second segment of our Q2 investment strategy meeting. Our deliberations focused primarily on determining the best manner in which to implement our previously stated goal of positioning your portfolios in assets we believe offer the strongest staying power and financial strength through the recession we believe we are now in while also offering strong recovery potential when things improve. What this means essentially is we have taken actions to better concentrate your investments in ETFs containing the highest quality stocks (we refer to them as the “stalwarts”) that we believe have the strongest market positions, financial strength and sustainable cash flows.

To provide a little more detail on our changes to your portfolios, within equities, we significantly boosted your concentration to large cap stocks primarily within the technology and health care sectors of the economy while reducing exposure to smaller cap stocks which are inherently less financially secure. This change provides increased concentration within your portfolios in “stalwart” companies like Microsoft, Apple, Amazon, Walmart, Costco, Merck and Johnson & Johnson. You will see in your accounts additions of several new ETFs that give us this exposure including the XLK (technology ETF), IHE (U.S. pharmaceuticals ETF), and RTH (U.S. retailers ETF). To determine the best ETFs to implement this strategy, we thoroughly analyzed the balance sheets and cash flow strength of the top five companies in these ETFs to be sure we were investing in companies with above average cash flow relative to debt. I would also note that as part of our strategy process, we took the opportunity to streamline or reduce the number of individual ETF holdings within the models. This allows us to better concentrate your investments in the areas we believe will serve us all best in the upcoming economic and market environment.

With respect to your holdings within fixed income, we decided to concentrate for now solely on U.S. Treasury notes and bonds, which are considered the strongest bonds in terms of credit quality. We eliminated holdings within mortgage-backed bonds, preferred stocks and high yield debt as we want at this time to concentrate holdings in the highest quality credits. We are now overweight a normal allocation in the long and intermediate maturity sectors within bonds, and at a normal weight in short term bonds. In terms of portfolio macro allocation, our actions reduced net equity exposure slightly, while increasing fixed income exposure. Exposure to REITs and small cap stocks was also reduced.

Some final thoughts…. This has been an unprecedented and turbulent time for all of us. We have seen unprecedented volatility and the fastest decline by far into bear market territory in history. Making forward-looking estimates of the economy and corporate profits right now is probably more difficult than any of us on the committee have ever seen in our careers. That is why we believe investing more of your assets in blue chip “stalwarts” offers some risk protection because of their strong business position and cash flows, and with the extent of the downturn uncertain, we want to be in the strongest companies financially. We did set an investment trigger, as we do at every meeting, that would cause us to re-evaluate and most likely increase our equity exposure if there was a new, positive development with respect to a medical treatment  or vaccine for COVID-19, or an indication that new cases were peaking or coming down which would result in improved economic activity. We wish everyone the best of health and stability in the forthcoming days. 

S.R. Schill & Associates.

Update on market volatility and portfolio change

We commented last Friday on the recent market volatility driven by Corona virus fears and uncertainty. We believe these anxieties are valid but when looking at the history of the past 50 years or so, we have had multiple viral outbreak episodes from which the stock market has always recovered and moved on to higher levels. As we stated Friday, we believe this will be the case with Corona. Like everyone else, we do not know how long this will take to play out, it could be several months or more. But as history shows, these events have historically been buying opportunities. Regardless, as we stated Friday, your financial plans incorporate the impacts of market volatility and your portfolios are designed, through their diversification, to mitigate stock market risk.

With this in mind, our investment committee met on Monday to assess this situation and possible further risks it may place on client portfolios. One action we took following our meeting on Monday was to eliminate our holding in the Transportation stock ETF (IYT) and move those funds into the Healthcare Technology ETF (IHI). We did this because we believe earnings reports for transportation stocks (particularly airlines and trucking companies) may be rather ugly over the next couple of quarters and there is higher likelihood of further downside resulting from these quarterly earnings reports. By re-allocating this money to IHI, we believe we are accomplishing several objectives: 1) reducing exposure to companies that would suffer from the corona situation to companies that will benefit from it;  2) moving money into a higher and more stable growth sector; and 3) moving funds into a far less volatile sector of the market.

We also discussed a number of additional possible actions at the meeting but came to the conclusion that it was not prudent or necessary to make further changes at this time. We will be holding our 2Q investment strategy meeting later this month and at that time will re-assess the situation and take actions on any strategic rebalancing we feel may be necessary at that time.

As always, if you have questions or concerns, please do not hesitate to contact us.

S. R. Schill & Associates

Comment on Recent Market Volatility

The recent market correction, as with all corrections, is unsettling. What makes this one a little more unsettling is the velocity at which the correction has taken place: down 13.5% in about seven trading days. That is a record. Of course panic and fear about the corona virus has been the catalyst; but the market was overdue for a correction as tech stocks in particular got to a short term overvalued position. Some “air” had to come out this market (we mentioned our January commentary the growing probability of a correction) and corona gave them the reason to sell. As we’ve said before, corrections are normal and are to be expected. The stock market “corrects” (meaning a decline of 10-20%) about once every 13 months, on average, and experiences “adjustments” (down 5-10%) about 3 times a year, on average.

As of now, no one knows how badly the corona virus may proliferate throughout the world. We can look to history of these events to give us some perspective. We do know that there will be economic and supply chain disruptions that will most likely result in a temporary period of slower economic growth (this is the main reason why the market has declined). We do know that over the past 30 years, there have been about 12 major viral epidemics. These have unfortunately resulted in loss of lives; but the global economy has always gone on to recovery and growth, and we believe this will be the case with corona.

It is highly likely the corona virus will dissipate over time like the 12 other viral events in the past 30 years. It is highly likely the world economy will get back on track after a period (perhaps a quarter or two) of slower growth. We believe it is unlikely that this event will result in a recession in the U.S. We note that Microsoft and Google both announced this morning that they are shifting production out of China to other countries, evidence that the supply chain is already adjusting. We are also encouraged by the recent actions of the CDC and other U.S. health organizations to prepare for a possible increase in cases in the U.S. which we believe should help to mitigate its impact in the U.S.  

While we cannot forecast the future (no one can), we believe the market has gone quite a ways in discounting a pretty negative scenario. We do not believe this is time to panic or panic sell; we would not recommend that in any event as the people who get hurt are the ones who panic along with them. And as we’ve said many times in the past, your financial plan incorporates the impact of inevitable market corrections. Further, your investment portfolios are designed specifically to mitigate the impact of volatility because 1) they are diversified across multiple asset classes and 2) they are allocated in such a way as to provide the growth you need to meet your plan goals while limiting portfolio risk.

As always, if you have questions or concerns, do not hesitate to contact us.

Robert Toomey, CFA/CFP

Vice President, Research

1Q Investment Strategy Meeting Summary

We held our 1Q-2020 investment strategy meeting on December 20, 2019. Following our meeting, we increased exposure slightly to both equities and fixed income due to the addition of several sector ETFs which we believe will benefit performance in 2020. We think the outlook for equities remains positive for 2020 although we think the probability for a modest correction sometime in Q1 has increased due to rising bullish sentiment.  Within bonds, we continue to underweight longer duration as we believe rates will most likely rise in 2020.

We think the positive underpinnings for further gains in stocks in 2020 include improved earnings, low bond yields, and potential for higher valuation. A number of signs remain positive for the performance of the U.S. economy in 2020 which has positive implications for 2020 earnings. These include: strong consumer confidence and spending, low unemployment, a Phase 1 trade deal with China, accommodative Federal Reserve policy, and prospects for improved capital spending. We believe the recent agreement with China for Phase 1 of a trade deal has positive implications for the U.S. and the global economies which we believe could lead to increased business confidence, higher capital spending, and higher corporate earnings in 2020. Risks to our U.S. outlook would be a significant delay or unwinding of the recent Phase 1 trade deal with China, a jump in inflation (which we don’t expect), and Presidential politics.

Speaking of Presidential politics, so far the markets appear to be viewing the recent impeachment of President Trump as a non-starter. This is reflected in a rising stock market throughout the recent proceedings. We think the market currently believes 1) it is unlikely Trump gets convicted by the Senate; and 2) there is/will be little impact or change in Trump’s economic policies from his impeachment. This view could change significantly next year depending on the course of the Presidential campaign and/or continuance of impeachment proceedings.

We believe prospects for international stocks have improved due to the improved likelihood of a Phase 1 trade deal with China. We believe consummation of a trade deal would have a positive impact on the global economy. As a result of this improving outlook, we increased our allocation to international stocks by about 2.7%. We added a small position in emerging market stocks (JPEM) which we believe present a good value opportunity if the Phase 1 trade deal plays out successfully.

Within the fixed income area, we added two positions to increase income. We added a small position in preferred stocks (PFF, as a bond substitute), and added a position in mortgage-backed bonds (SPMB). Both positions offer a significantly higher yield than our core bond holdings, about 2.5x higher for PFF within long bonds, and about 60% higher for the SPMB within intermediate bonds.

We updated our investment action trigger, which is now an increase in the 10-Year U.S. Treasury bond yield to 2.75% (currently 1.93%), which would have negative implications for financial assets. This would imply that inflation and/or interest rates are rising much faster than we expect. Setting of action triggers allows us to 1) be proactive in managing portfolio risk and 2) think about risks in a more calm environment and not have to react under duress.

All of us at S. R. Schill & Associates send our best wishes for a happy holiday season and a healthy and prosperous 2020 !

Robert Toomey, CFA/CFP

Vice President, Research

Research Director Monthly Comment: Finding Your Strawberries

Year-end in the investment and financial services business is traditionally the proverbial “forecasting season” in which many firms issue their fearless prognostications for the forthcoming year relating to such things as financial market returns, interest rates, the economy, Federal Reserve policy, etc. In truth, it is important stuff: having the best, or at least, better vision into the future is certainly a huge advantage in investing. The problem with the “forecasting” business is no one can forecast the future precisely; if we could we wouldn’t be……well, you know how the rest of it goes.

History shows that pundits and forecasters you read about or see on TV are right about half of the time, the equivalent of a coin toss. So are their forecasts worthless? Not necessarily. The pundits can provide ideas, data, and food for thought that can be helpful in formulating investment strategy. Having an investment strategy based on fundamental analysis is part of our due diligence in managing client assets. In an environment of uncertainty, we do this primarily through deriving probabilistic assessments of the factors that will impact future market and portfolio performance. In short, as of now our best probabilistic assessments for the economy and stock market in 2020 remain positive.

Importantly, in an environment of uncertainty where we know things will happen that we cannot currently forecast, there are always actions we can take to enhance our probability for financial success. Think of it as “finding strawberries” in a roughed up and messy garden, “strawberries” being positive things that are tangible in an environment of uncertainty. Here are six “strawberries” we see for 2020.

1.       1. The economy should again be strong in 2020. This is based on strong employment and good probability for robust consumer spending and stronger capital spending.

2.       Good probability for improving corporate profits which are the underpinning of stock prices.

3.       Good probability that global central banks will remain accommodative. This implies healthy liquidity to the financial system and is a positive for valuations of financial assets.  

4.       The ability to be proactive in positioning oneself better financially for 2020. This includes such things as improved spending and budget discipline, establishing a more disciplined savings program, reducing debt, tax planning, and/or maxing out tax qualified savings plans such as IRAs and 401Ks.

5.       The ability to take steps to improve one’s financial future through implementing a comprehensive financial plan that focuses on long-term financial goals and improving one’s financial health and readiness for retirement.

6.       Being proactive in managing portfolio risk through appropriate asset allocation, asset class diversification, and adhering to a disciplined financial plan.

Robert Toomey, CFA/CFP

Vice President, Research

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

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