Big thanks to all the Veterans out there! Only two links this week. The first one is long but it’s a great look at health care costs in retirement.
We tell clients to avoid financial media headlines because they are often misleading. As an example, below are three links CBS MarketWatch article . To call these clickbait would be an understatement. These three headlines appeared within 3 hours of each other!
The best is the first one. When you actually read what Shiller said he actually went on to explain he sees very little chance of a repeat of 2008 in the housing market.
Even if these predictions are correct most investors should still do nothing. Doing nothing is the hardest thing to do, especially when media outlets are putting out headlines like this mess. They take snippets from people and then use them out of context. But, it worked. I clicked on them and now you probably will too. Just remember, these “experts” know nothing more about what is going to happen than you and I.
October is shaping up to be one the most volatile months this decade and questions of "is this the start of a market crash?" are resurfacing. Of course no one knows that answer and while equity markets, specifically US, have not experienced a prolonged sell off in years, there are some encouraging signs amidst this wave of selling pressure.
While 2008 feels like a lifetime ago, it is important to remember what we experienced then vs.what is occurring now. During 2008, the S&P 500 declined 8 out of 12 months vs. 3 so far in 2018 (including October). Five of the monthly declines experienced in 2008 were 5% or greater and we have only experienced three months of similar magnitude since June of 2012. This is not to make light of the current volatility we are experiencing, but more so to put things in perspective. It is true that many global markets have experienced much higher levels of volatility over the years, but that is to be expected at times.
Historically, the types of drops we are experiencing are normal. Its hard to wrap our heads around this but it is much more "normal" than the type of run up the S&P 500 had over the last several years.
A barometer I look at during periods of extreme volatility are how defensive sectors (i.e. Consumer Staples and Utilities) are performing. The simple logic here is at the end of the day we still need things like toilet paper, toothpaste, shampoo. During tough times consumersstill consume power (utilities). If these sectors experience similar declines, then itcouldbe a sign of more troubling timesahead. In 2008, every sector experienced double digits declines. Most of these were-20%or more. This would be a prime example of panic selling. AsI write thison October 24th,consumer staples and utilities are positive for the month, while sectors such as Materials, Consumer Discretionary, Energy & Technology are down -9% to -13%. This could indicatesome of the selling is systematic, not panic, as investors move from economically sensitive sectors to more defensive ones. The technology sector has soared for 5 straight years which has increased the risk to the underlying markets. Afew tech names (Apple, Microsoft & Amazon) now comprise ~11% of theS&P 500, nearly double of what it was in2016! That is a staggering increase and leads to higher potential volatility as fewer names have a bigger impact on the broad indices. With fears of rising interest rates, tariffs and possible slow down in global earnings on the horizon, this sell-off is not entirely unexpected. It is not realistic to assume that the technology sector would continue to experience double digit annual returns. We have been critical of the Federal Reserve in the past for waiting far too long to raise rates and they are now dealing with it head on. It seems the current Federal Reserve is now boxed in a corner with less options to their disposal. Add the tariff issue and things are ripe for volatility.
The ironic thing is during the first half of 2018, consumer staples and utilities were near the bottom of the pack but are making a strong comeback and utilities are now near the top. I have said in the past and continue to say that orderly market corrections, like what we have experienced so far is healthy and at times needed. When markets go up on a straight line (i.e. 2017) and ignore warning signs along the way, that is worrisome and can lead to a much larger correction. While never fun, and this sell-off could continue, it is important to take a step back and remember this is what markets do. It can test your patience and cause you to worry, which is normal and expected.
Please don't hesitate to contact us with any questions or concerns, that is what we are here for.
I’m just going to leave this chart of the Russell 3000 Total Market Index right here.
Foregoing links this week and giving some thoughts….
Facebook, Amazon, Apple, Netflix, and Google (now Alphabet) felt the brunt of the big drawdown this week. They lost over $175 Billion on Wednesday alone. Let’s think about this for a moment. These are five of the largest, best-performing tech stocks in the world.
Where did the money go? What did people who pulled out of these stocks do with their cash?
They likely moved it to cash to wait.
Wait for what? Wait to get back in. These are the speculators, computer algorithms and the un-disciplined. They looked “smart” on Thursday when the selling continued. They may look smart for weeks to come but you better believe they will be sweating trying to figure out when to get back in.
Who needs that stress? People who make a living day trading. People who need higher than average returns to pay their mortgage. People who are so far off track for retirement they are throwing hail mary passes in the hopes of being able to retire like their neighbor who stuck with a proven strategy.
If you are mostly in index based funds you don’t have this stress. The fund will hold these stocks today, tomorrow and in the months to come. You don’t have to worry that a fund manager or their algorithms are trying to time the buying and selling of these stocks.
This is a little tongue-and-cheek. Of course you care but I hope you get what I am saying. Remember the type of investor you have been and will continue to be. Even if it stresses you out try to remember you’re strategy is meant to eliminate emotion, decrease stress and perform over the long term.
And, if this is the next inevitable market downturn then guess what? You are prepared and that’s all you can do. Take solace in the fact that even though it hasn’t been the norm for a while, market corrections and bear markets are quite normal. Its what makes the whole thing work. If the market didn’t have drawdowns then it couldn’t have run-ups and set all-time highs either.
We talk a lot lately about how a diversified portfolio is hard to stick with when one single asset class like the S&P 500 seems to be destroying everything else in terms of returns over the past 5 years. The below snapshot is from the first link below. Long term thinking must be used when it comes to diversification.
In nearly every market commentary we mention how important diversification is to an investment portfolio. In 1952 Harry Markowitz introduced Modern Portfolio Theory which further expanded upon the benefits of diversification. The concept seems straightforward and logical yet time and time again many stray from it. The question is why? Why do investors give up on a strategy that "works".
Diversification shows its true benefit over the long run. The issue is there are periods of time where a single asset class’ performance dominates the others. Sometimes these periods can be several years long. For example, from 2004-2007 Emerging Markets returned an impressive ~132.9%. From 2009 to 2012 REITS (Real Estate Investments Trusts) returned ~84%. And more recently, from 2014-Present, the S&P 500 (Large Cap US Stocks) has returned ~60% (as of this writing). No other asset classes have come close to this same performance in those periods. This type of outperformance leads many to abandon diversification and overweight their portfolios with asset classes that have experienced the best returns. Many forget the years prior and after as to how significantly these same asset classes underperformed their peers. We do believe one should slightly overweight or underweight certain asset classes based on macro economic factors, but too much can wreck havoc on a portfolio's long term stability.
Over the past four years, excluding2017, diversification has not treated investors well as Bonds, International, REITS & Emerging Markets have lagged S&P 500 performance. The S&P 500 has shown extreme resiliency at every turn and recently has benefited from corporate tax reform, stock buybacks, and a growing U.S. economy. You may be asking yourself, why not just own this asset class as it's comprised of the 500 largest (or most "important") U.S. publicly traded companies and has been rock solid the past six years? The answer lies in the details. Owning solely the S&P 500 or any other asset class for that matter will most likely lead to a positive return over the long run. The challenge is you will have to deal with long stretches of underperformance that are difficult to endure if all of your money is in a declining or underperforming asset class. Take a look from 2004-2010; the S&P 500 was in the middle of the pack or lower for SIX straight years. While it did yield a positive return, it significantly trailed other asset classes. Both stock and bond markets are forward looking mechanisms so looking at past performance generally is not a recipe for success. Most people would look to jump ship into the better performers. This creates a loop that leads to chasing returns and market timing.
While 2018 really hasn't been kind to diversified portfolios, it is important to remember the goal of diversification is not outperformance. Rather, it is to minimize the fluctuations and earn an efficient risk adjusted return. There are periods in the short term where diversification may not seem effective, but the long-term results speak for themselves. The key to diversification is sticking to it over time and this will challenge you at times. A properly diversified asset allocation portfolio that is rebalanced regularly aims to smooth out the bumps and place your portfolio in the middle to upper middle of the pack most years.
The Fed raised rates again this week. It got lost in the media shuffle with the political coverage this week. Rates continue to climb up. The 10 year is above 3% again and the markets didn’t collapse so that is a win.
Marijuana stocks were in the news the past couple of weeks. These volatile stocks are the new bitcoin it seems. Speculators (not investors) are using the volatility to try and make a quick return. Don’t be fooled. You can’t out time the pros on this one.
Fidelity launched a zero fee index fund last month and turned the financial media on its head. Not because it was unexpected but because it wasn’t expected this soon. I assumed it would be either Vanguard or iShares to do it first. Fidelity figures it will make money from people using their other funds to more than offset the “cost” of the free funds. It is yet to be seen how this may affect their higher fee managed funds.
This is yet another win for investors. There could be a time in the not to distant future where the only fee investors pay is to their financial planners. It will be transparent and fully understood and the days of selling and commissions will be over. All “advisors” will be fiduciaries and fee-only. Humbly we can say we were ahead of this curve.
We talk a lot about how important technology is to our business. It’s our largest expense. I’d put our efficiency, processes and workflows up against any firm our size. This is mostly due to the way we use the technology we have. Since the very beginning (when we had very few clients) we built out our processes as if we had hundreds of clients. We were scaling before scaling was a thing. I thought a little more about it this week and I think if this were 1995 we would probably need at least 10 people to do what our technology does. That would mean higher costs to clients. Or, we’d have to cut our client base in half. Something would have to give. Luckily, its 2018 and financial technology is booming. Because of the competition the vendors we use are always improving.
Enjoy this week’s links…
Good synopsis in the first link about why the US stock market has been relatively immune to news. We have talked about the market’s resiliency for quite a while now. It’s hard to fathom that next week will mark the 10 year anniversary of Lehman Brother’s bankruptcy. The S&P proceeded to lose over 50% of its value over the next 18 months. It dropped to around 750 points and as I write this the S&P is at about 2900 points. Ten years can seem both like a long time frame and a short time frame. When the next sustained downturn occurs I’m sure we will use examples of the depths of the 2008/2009 plunge to show it could always be worse.
What is an Inverted Yield Curve and why is it in the financial news lately? In short, an inverted yield curve occurs when long-term debt (10 Year Treasury) has a lower yield than short-term debt (2 Year Treasury) of the same credit quality.
Typically, banks borrow short term and lend money out long term and the interest rate spread (difference) compensates banks for the risk assocaited with lending. When a bank generates less income on their assets (long duration loans) than their liabilities (short-term deposits), the incentive for new loans starts to dwindle and can cause a disruption in the money supply.
Add to the equation the Federal Reserve is attempting to unwind their balance sheet and tighten monetary policy after 7 years of near zero interest rates and the "conundrum" becomes more complicated. Since the low rates have directly inflated certain asset classes, the unwind is expected to be slow which won't help push up long term rates.
The slow down of interest rates on long term bonds indicates there is a concern for long term economic growth. That in itself isn't a cause for alarm but, as mentioned above, when this occurs at the same time the Federal Reserve is raising short-term rates, the gap between short term rates and long term rates continues to shrink. The closer it gets to inverting, the louder the alarm bells get.
The last seven recessions dating back to the 1960's have occurred when short-term rates have exceeded long term-rates. It is important to remember that recessions are not based off one data point and that each recession is unique in its own way but this is still something that should be monitored closely. The Federal Reserve has limited control over long term rates as because those are shaped by inflationary expectations. The Federal Resererve uses their power to influence short term/overnight lending rates. The yield curve inverts when the Federal Reserve believes inflation is headed higher but bond investors are expecting the opposite.
What is a bit different this time is the national debt is over $20 trillion and the Fed's balance sheet sits a tad over $4.5 trillion while, at the same time, interest rates still remain low. None of these existed when the Great Recession took hold in 2008 and left the Federal Reserve with plenty of ammunition to step in and help. That is no longer a luxury and has some worried as to what will happen in the next downturn when these mechanisms won't be available. The wild card here is economic growth. Obviously we don't know what it will be in the coming quarters but an economic slow down in the face of an inverting yield curve is not a desired outcome and could wreak havoc on financial markets. While GDP growth and productivity have been improving lately, we need to see this for a few more quarters before declaring any sort of victory.
After almost 16 years in the industry I find it hard to believe “sales contests” still exist. In an era where a standardized Fiduciary Rule is imminent it is still a common practice for companies to offer sales contests for certain products. Yes these conflicts of interests are disclosed somewhere in the paperwork their clients sign but this is still crazy. If the SEC fixes this then they should also stop the steak dinners wholesalers do for advisors on a regular basis. Free steak and free wine is a conflict of interest.
The S&P 500 hit an all-time high this week. It is also marking the longest bull market for the index in its history. This is an arguable “fact” however given the several major dips the index has recorded. In early 2016 and earlier this year the market was down well past correction territory. It flirted with what could be consider “bear market territory”. All of this has helped make this not only a very long bull market but also the most distrusted. The financial newsletter industry is a multi-million dollar industry. Most of these sell fear. They have been calling for the end of the bull market for 5+ years. They have been wrong almost every step of the way. Far more money has been lost in the last 5 years on the sidelines than will likely be lost in the next market down turn.
First link this week is about Elon Musk possibly taking Tesla private. Musk made news when he hinted at the possibility in a tweet. If you are musk there are a lot of positives to this line of thought. Plus he can spend less time arguing with analysts.
Bad Blood is the story of the Theranos scandal and it’s founder, Elizabeth Holmes. With a movie in the works starring Jennifer Lawrence I’m sure you will hear more about it in the future. The book is a must read for any investor. The entire time I was reading the great book I kept asking myself how could so many high profile people be fooled? The list is quite impressive. Henry Kissinger, the Obamas, the Clintons, the Walton (Wal-Mart) family, the Cox (cable) family, Robert Murdoch (News Corp), Bob Kraft (Patriots)…the list goes on and on. As the author points out, the fear of missing out drove most of these investors. They were duped and they let their fears and emotions drive their investment decision.
What you don’t see on the list is many professional investors. Where are the healthcare VCs? Where are the big Silicon Valley early investors? There were few. Why? Because they actually conduct due diligence on their investments. That’s not to say every investment they make works out but they are rarely deceived.
I highly suggest the book but the first link below is a podcast interview with the author.
I have to add commentary to the first link below and apologize for diverting away from finance in this one. First, I can’t believe how many people die from dogs. Second, who knew freshwater snails were so savage?
Tech stocks (specifically Facebook) got pummeled this week. The NASDAQ took quite a hit. This isn’t extremely alarming as long as you have a diversified portfolio.
No post next week so enjoy this week’s links. I hope to have the time over the next week to read Bad Blood: Secrets and Lies in a Silicon Valley Startup. The insanity and story behind Theranos still seems underrated. I don’t know why it didn’t catch on as an even bigger story. I’m sure a documentary or movie is in the works.
We have addressed the “trade war” enough in other posts so we are taking a much needed break from it. I guess you could call today the “start” of the trade war in a way. It isn’t going away anytime soon so we will have plenty of time in the weeks ahead.
Nonetheless, here are some good reads…