Did You Exit After Brexit?

The pundits had it all wrong with the Brexit vote (I too was wrong on the British vote to exit from the European Union).

With the benefit of hindsight, we can see that it would have been a bad idea to sell your stock holdings after the Brexit vote; you would have locked in a 5% to 10% loss in a market that has trended upward to new record highs.  The same is true of the aftermath of the World Court decision that slapped China in the face by declaring that man-made islands don’t transform an ocean into territorial waters, the attempted coup in Turkey, or, really, any other alarming headline which doesn’t materially affect a company’s ability to run its operations or earn a profit.

But the bigger issue is that, even if you knew the outcome of the vote, you still wouldn’t have known how markets were going to react.  How would you know whether quick-twitch traders would buy or sell the event?  After the Brexit vote, it took a weekend for investors and traders to realize that this was Britain’s problem, not theirs.  Realistically, it could have taken a month, or even a year to play out.

The same is true for the time period that we’re heading into now.  As you can see from the accompanying chart, the average return for various months of the year has been pretty much the same across the spectrum.  But August, September and October have seen bigger highs and (most alarmingly) also deeper lows, on average, than other months.  This additional volatility seems to be random, and is, once again, impossible to time.  People who decide to side-step the late summer and early fall would miss out on average yearly gains for September and October of 1.05% and 1.21%.  (Skipping August would have saved you modest losses of less than 1%, on average, but one suspects that this is a statistical anomaly.) The month of August in election years, even during the bear market of 2008, tends to have a positive bias; will this year be one of them?

CA - 2016-8-3 - Riding the coaster

Finally, biggest picture of all, the current bull market, which started March 9, 2009, has now become the second-longest bull market on record, beating the June 1949 to August 1956 rally.  It is second only to the December 1987 to March 2000 advance.  In terms of percentage change, we are experiencing the fourth strongest bull market on record.

Doesn’t that mean it’s time to take our chips off the table?  If we knew how to consistently time the market, if we could be sure that the market run won’t continue to run up for another few years, then the answer would be yes.  But with the economy continuing to churn out positive gross domestic product (GDP–the measure of our output of goods and services), with inflation low and unemployment continuing to fall, and central bankers supplying liquidity and stimulus to the markets, it’s hard to see what would cause U.S. stocks to be less valuable in the near future than they are today.

Meanwhile, once again, even if we did exit, how would we know when to get back in?  Investors who bailed during the 2008 downturn missed much of the surprise upturn that began this current bull run.  Those who hung on more than made up for their losses, even though it seemed like every year would be the bull market’s last. One thing that I’ve learned from doing this for so long, is that moves in the market (in both directions) usually go on far longer than most people can imagine.

There isn’t a day where some market “expert” or pundit comes out and says he likes nothing in this market and to sell everything? … Really?? Sell everything?! It angers me how reckless these statements are. Giving blanket advice to people is irresponsible. You don’t know the person’s goals, age, risk tolerance, time-frame, etc. But fearful headlines will always attract eyeballs, and most of these pundits have something to sell you. Don’t buy it. Maybe you should sell some things, but always do your own due diligence and always keep in mind your long-term goals.

It’s nearly certain that there will be a lot of scary headlines between now and the end of the year, and it’s quite likely that the investment roller coaster is about to get bumpy.  All of us wish that we had a working crystal ball to help us navigate through uncertainty, but all we have is the historical record, which says that after the next downturn, the market will eventually experience a new high (yes, this will happen regardless of who becomes our next president).  We want to be there to celebrate it.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources: 

https://www.washingtonpost.com/business/get-there/given-the-brexit-brouhaha-how-did-your-investments-hold-up/2016/07/22/a7bc1198-4d03-11e6-a7d8-13d06b37f256_story.html

http://www.investmentnews.com/article/20160801/FREE/160809992/if-history-is-a-guide-market-volatility-is-about-to-spike

http://www.cnbc.com/2016/07/13/merrill-second-longest-bull-market-ever-has-further-to-run.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Second Quarter 2016 YDFS Market Review

The official start of summer was only a few days ago, but the market already feels like it’s taken us on a wild roller coaster ride this year. It certainly makes us feel like we’re in a bear (sideways to down) market, what with the surprising “Brexit” vote in the UK, the dismal first few weeks of the year and increased volatility across the board.  So it may come as a surprise that the second quarter of 2016 eked out small positive returns for many of the U.S. market indices, and most of them are showing positive (though hardly exciting) gains over the first half of the year.

The Wilshire 5000 Total Market Index–the broadest measure of U.S. stocks and bonds—was up 2.84% for the quarter, and is now up 3.69% for the first half of the year.  The comparable Russell 3000 index gained 1.52% for the quarter and is up 2.20% so far this year.

The Wilshire U.S. Large Cap index gained 2.65% in the second quarter of 2016, putting it at a positive 3.94% since the beginning of January.  The Russell 1000 large-cap index provided a 1.44% return over the past quarter, with a gain of 2.34% so far this year, while the widely-quoted S&P 500 index of large company stocks posted a gain of 1.90% in the second quarter, and is up 2.69% for the first half of 2016.

The Wilshire U.S. Mid-Cap index gained 4.33% for the quarter, and is sitting on a positive gain of 6.67% for the year.  The Russell Midcap Index is up 1.54% for the quarter, and is sitting on a positive gain of 3.82% for the year.

Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 4.09% return during the second quarter, up 4.98% so far this year.  The comparable Russell 2000 Small-Cap Index gained 1.96%, erasing gains in the first quarter and posting a 0.41% gain so far this year, while the technology-heavy Nasdaq Composite Index lost 0.56% for the quarter and is down 3.29% for the first half of 2016.

When you look at the global markets, you realize that the U.S. has been a haven of stability in a very messy world.  The broad-based EAFE index of companies in developed foreign economies lost 2.64% in dollar terms in the first quarter of the year, and is now down 6.28% for the first half of the year.  In aggregate, European Union stocks lost 7.60% in the first half of 2016.  Emerging markets stocks of less developed countries, as represented by the EAFE EM index, lost 0.32% for the quarter, but are sitting on gains of 5.03% for the year so far.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, was up 5.60% for the second quarter, with a gain of 11.09% for the year.  Commodities, as measured by the S&P GSCI index, gained 12.67% of their value in the second quarter, giving the index a 9.86% gain for the year so far.  The biggest mover, unsurprisingly, is Brent Crude Oil, which has risen more than 15% in price over the quarter.

Meanwhile, interest rates have stayed low, once again confounding prognosticators who have been expecting significant rate rises for more than half a decade now.  The Bloomberg U.S. Corporate Bond Index is yielding 2.88%, while the Bloomberg U.S. Treasury Bond Index is yielding 1.11%.  Treasury yields are stuck near the bottom of historical rates; 3-month notes yielded 0.26% at the end of the quarter, while 12-month bonds were yielding just 0.43%.  Go out to ten years, and you can get a 1.47% annual coupon yield.  Low?  Compared with rates abroad, these yields are positively generous.  If you’re buying the German Bund 10-year government securities, you’re receiving a guaranteed -0.13% yield (yes, that’s a negative yield).  The 5-year yield is actually worse: -0.57%.  Japanese government bonds are also yielding -0.3% (2-year) to -0.23% (10-year). Can you imagine paying someone to hold your money for you?

On the first day of July, the Dow, S&P 500 and Nasdaq indices were all higher than they were before the Brexit vote took investors by surprise, which suggests that, yet again, the people who let panic make their decisions, lost money while those who kept their heads in it, sailed through.  There will be plenty of other opportunities for panic in a future where terrorism, a continuing mess in the Middle East, a refugee crisis in Europe and premature announcements of the demise of the European Union will deflect attention away from what is actually a decent economic story in the U.S.

How decent?  The American economy is on track to grow at a 2.0% rate this year, which is hardly dramatic, but it is sustainable and not likely to overheat different sectors and lead to a recession.  Manufacturing activity is expected to grow 2.6% for the year based on the numbers so far, and the unemployment rate has fallen to 4.7%, which is actually below the Federal Reserve target.  Inflation is also low: running around 1.4% this year.  The unemployment statistics are almost certainly misleading in the sense that many people are underemployed, and a sizable number of working-age men are no longer participating in the labor force, but for many Americans, there’s work if you want it.  Historically low oil prices and high domestic production have lowered the cost of doing business and the cost of living across the American economic landscape.

Despite all this good news, the market is struggling to keep its head above water this year, and is not threatening the record highs set in May of last year. But we’re close, and I suspect that we will challenge and rally above the old highs soon.

Questions remain.  The biggest one in many peoples’ minds is: WILL the European Union break up now that its second-largest economy has voted to exit?  There is already renewed talk of a Grexit, along with clever names like the dePartugal, the Czechout, the Big Finnish and even discussion about Texas (Texit?) leaving the U.S.  How long before we hear about (cue the sarcasm) some localities declaring independence from their states?  With active political movements in at least a dozen Eurozone countries agitating for an exit, is it possible that someday we’ll view the UK as the first domino?

A recent report by Thomas Friedman of Geopolitical Futures suggests that the EU, at the very least, is going to have to reform itself, and the vote in Britain could be the wake-up call it needs to make structural changes.  The Eurozone has been struggling economically since the common currency was adopted.  It is still dealing with the Greek sovereign debt crisis, a potential banking crisis in Italy, economic troubles in Finland, political issues in Poland and, in general, a huge wealth disparity between its northern and southern members.  Is it possible that a flood of regulations coming out of Brussels is imposing an added burden on European economies?  Should different nations be allowed to manage their policies and economies with greater independence and focus?

Friedman thinks the UK will be just fine, because Europe needs it to be a strong trading partner.  Britain is Germany’s third-largest export market and France’s fifth largest.  Would it be wise for those countries to stop selling to Britain or impose tariffs on British exports?  And more broadly, with the political turmoil in the UK, is it possible that there will be a re-vote, particularly if the European Union decides to make reforms that result in a less-stifling regulatory regime?

You’ll continue to see dire headlines, if not about Brexit or the Middle East, then about China’s debt situation and the Fed either deciding or not deciding to raise rates in the U.S. economy (it won’t).  Oil prices are going to bounce around unpredictably.  The remarkable thing to notice is that with all the wild headlines we’ve experienced so far, plus the worst start to the year in U.S. market history, the markets are up slightly here in the U.S., and the economy is still growing.  The chances of a U.S. recession starting in the next nine months are 10% or less.  Yes, your international investments are down right now, but eventually, you can expect them to come to the rescue when the American bull market finally turns.

When will that be?  If we knew how to see the future for certain, we would be in a different business.  All of us are going to have to resign ourselves to being surprised by whatever the rest of the year brings us, headline by headline. That, however, doesn’t stop me from making my own prognostication about what the market might bring.  By the end of the year, I think we’ll see mid-single digit gains for the year, after some hand-wringing over the election, in what I expect to be a rough September and October in the markets. But then again, I thought the Brexit would be voted down, so don’t bet your chips on any predictions anyone has, including me. This keeps us mostly invested with good hedges to absorb whatever volatility the market throws at us.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

Sources:

Wilshire index data.  http://www.wilshire.com/Indexes/calculator/

Russell index data: http://indexcalculator.russell.com/

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–

Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Aggregate corporate bond rates: https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

Aggregate corporate bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

http://useconomy.about.com/od/criticalssues/a/US-Economic-Outlook.htm

http://www.marketwatch.com/story/first-quarter-us-gdp-raised-to-11-2016-06-28?siteid=bulletrss

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

You Only Brexit Once (YOBO)

Not even a month ago, I wrote to you and shared my thoughts on Britain leaving the European Union (EU).  I guess I was wrong.

Thursday’s 52%-48% vote by the British electorate to end its 43-year membership in the European Union seems to have taken just about everybody by surprise, but the aftermath could not have been more predictable.  The uncertainty of how, exactly, Europe and Britain will manage a complex divorce over the coming decade, sent global markets reeling.   London’s blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day, while Germany’s DAX market lost more than 7%.  The British pound sterling is getting crushed (down 14% against the yen, 10% against the dollar).

Compared to the global markets, the reaction among traders on U.S. exchanges seems muted; down roughly 3%, though nobody knows if that’s the extent of the fall or just the beginning. I think after a bit of a hangover on Monday, Wall Street will move on to the next brick in the Wall of Worry that builds bull markets.

The important thing to understand is that the current market disruptions represent an emotional roller coaster, an immediate panic reaction to what is likely to be a very long-term, drawn out, ultimately graceful accommodation between the UK and Europe.  German companies are certainly not 7% less valuable today than they were before the vote, and the pound sterling is certainly not suddenly a second-rate currency.  When the dust settles, people will see that this panicky Brexit aftermath was a buying opportunity, rather than a time to sell.  People who sell will realize they were suckered once again by panic masquerading as an assessment of real damage to the companies they’ve invested in.

What happens next for Britain and its former partners on the continent?  Let’s start with what will NOT happen.  Unlike other European nations, Britain will not have to start printing a new currency.  When the UK entered the EU, it chose to retain the British pound—that, of course, will remain.  Stores and businesses will continue accepting euros.

On the trade and regulatory side, the actual split is still years away. One of the things you might not be hearing about in the breathless coverage in the press, is that the British electorate’s vote is actually not legally binding.  It will not be until and unless the British government formally notifies the European Union of its intention to leave under Article 50 of the Lisbon Treaty—known as the “exit clause.”  If that happens, Article 50 sets forth a two-year period of negotiations between the exiting country and the remaining union.  Since British Prime Minister David Cameron has officially resigned his post and called for a new election, that clock probably won’t start ticking until the British people decide on their next leader.

After notification, attorneys in Whitehall and Brussels would begin negotiating, piece by piece, a new trade relationship, including tariffs, how open the UK borders will be for travel, and a variety of hot button immigration issues.  Estimates vary, but nobody seems to think the process will take less than five years to complete, and current arrangements will stay in place until new ones are agreed upon.

The exit agreement also requires obtaining the consent of the EU Parliament.  When was the last time the EU parliament got anything done quickly? The answer is never. Heck, even Prime Minister David Cameron’s splashy Friday morning resignation is not effective until October. For the foreseeable future, despite what you read and hear, the UK is still part of the Eurozone.

An alternative that is being widely discussed is a temporary acceptance of an established model—similar to Norway’s. Norway is not an EU member, but it pays EU dues, and has full access to the single market as if it was a member.  However, that would require the British to continue paying EU budget dues and accept free movement of workers—which were exactly the provisions that voters rejected in the referendum.

Meanwhile, since the Brexit vote is not legally binding, it’s possible that the new government might decide to delay invoking Article 50.  Or Parliament could instruct the prime minister not to invoke Article 50 until the government has had a chance to further study the implications.  There could even be a second referendum to undo the first.

The important thing for everybody to remember is that the quick-twitch traders and speculators on Wall Street are chasing sentiment, not underlying value, and the markets right now are being driven by emotion to what is perceived as an event, but is really a long process that will be managed by reasonable people who aren’t interested in damaging their nation’s economic fortunes.  Nobody knows exactly how the long-term prospects of Britain, the EU or American companies doing business across the Atlantic will be impacted by Brexit, but it would be unwise to assume the worst so quickly after the vote.

When I want to gauge the intermediate-term economic outlook, I often look at how the large commercial traders are positioned in copper. Being the most basic component of the home/commercial building engine, how they’re positioned in copper tells me how optimistic they are on the economy. As of this week, they’re positioned more bullishly in copper than they have been in the past few years. I would say that offers us some degree of hope about the future of the global economy, even if one country amounting to less than 1% of the global population decides that it doesn’t want to be in an economic union anymore with the rest of Europe.

But you can bet that, long-term, everybody will find a way to move past this interesting, unexpected event without suffering—or imposing—too much damage.  My guess is that the market will get back to its normal course of business by Tuesday or Wednesday and will have moved past this event. Meanwhile, hang on, because the market roller coaster seems to have entered one of those wild rides that we all experience periodically.

Sources:

https://www.yahoo.com/news/brexit-shows-global-desire-throw-142925862.html

https://www.washingtonpost.com/opinions/global-opinions/after-brexit-what-will-and-wont-happen/2016/06/24/c9f7a2f6-39f1-11e6-8f7c-d4c723a2becb_story.html

http://www.businessinsider.com/global-market-brexit-reaction-2016-6

http://www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html#ixzz4CVixCz25

http://www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html?ftcamp=traffic/partner/brexit/dianomi/row/auddev#axzz4CVide1Sz

http://www.newser.com/story/227149/brexit-now-what-happens-welcome-to-article-50.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Is the Weak Jobs Report Foretelling a Recession?

In case you hadn’t heard on Friday, the Bureau of Labor Statistics (BLS) Employment Report for the month of May was disappointing.  Economists who follow job growth in the U.S. economy were expecting 123,000 new jobs to be created.  The actual number, according to the BLS, was 38,000—the smallest gain since September of 2010.

What’s going on?  On a scale of 1 to Lehman, how worried should we be?  Is an 85,000 shortfall in job growth, in a single month, telling us that the U.S. economy is about to plunge into a deep recession? The short answer is no.

CA - 2016-6-3 - That Jobs Report

As it turns out, the investment markets largely shrugged off the surprising number—for a variety of reasons.  First of all, a strike affecting 35,000 Verizon employees was somehow factored into the data, so unless all the striking workers are never coming back to work, a real count would have put the job-adding number at around 73,000.  Second, the employment data comes with a huge asterisk: these are estimates with a margin of error of 100,000 jobs.  That means we won’t actually know how many jobs were created until sometime in the future. There are at least two revisions to be made in the future.

Third: despite the low job creation figure, the Bureau of Labor Statistics also told us that the unemployment rate is dropping, currently to 4.7%, the lowest rate since November 2007.  How can that be?  BLS statistics say that people are leaving the workforce at a faster rate than previously, but the economy has also been adding 180,000 to 200,000 jobs almost every month for the past five years.  Is it possible that it has finally given a job to most of the people who want one?

As evidence, the BLS has reported that hourly earnings by workers are up 3.2% for the first five months of 2016, which suggests that workers have a bit more pricing power than they did, say, last year.  That suggests that we are experiencing a tighter labor market, not one where jobs are falling off the table and many people are too discouraged to apply for a job.

Finally, the uncertainty over jobs has almost certainly delayed the rise in interest rates that had, before the report, been widely expected from the U.S. Federal Reserve Board in June or July.  You can expect the Fed to be more cautious about adding any costs to the economy until its economists can get a handle on what that odd job statistic means for the overall health of U.S. businesses.  That would give the economy a slight boost, and might lead to higher jobs growth figures in the future.

So how much did Friday’s employment news change the fundamental picture of economic growth or the prospects for stocks?

Not very much.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

Sources:

Wall Street Stunned!

http://www.businessinsider.com/wall-street-on-may-2016-jobs-report-2016-6

http://www.businessinsider.com/us-jobs-report-may-2016-2016-6

http://www.forbes.com/sites/samanthasharf/2016/06/03/jobs-report-u-s-adds-just-38000-jobs-in-may-unemployment-rate-down-to-4-7/?linkId=25155735#22a015b216da

https://www.washingtonpost.com/news/wonk/wp/2016/06/03/what-just-happened-with-jobs-in-america/?tid=sm_tw

http://www.ft.com/fastft/2016/06/03/us-markets-shake-off-grim-jobs-report/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

 

 

What’s Going on in the Markets January 18 2016

Wow! There’s no diplomatic way to say this: the global stock markets are in panic mode right now. In two weeks of trading, the U.S. S&P 500 index is down 8% on the year, which brings us close to correction territory (a 10% decline), and has some predicting a bear market (a 20% decline).

On top of that, we’ve been hearing a widely-publicized, rather alarming prediction from Royal Bank of Scotland analyst Andrew Roberts, saying that the global markets “look similar to 2008.” Mr. Roberts is also predicting that technology and automation are set to wipe out half of all jobs in the developed world. If you listen closely out the window, you can almost hear traders shouting “Sell! Head for the exits! We’re all gonna’ die!!!”

When you’re in the middle of so much panic, when people are stampeding in all directions, it’s hard to realize that there is no actual fire in the theater. Yes, oil prices are down around $30 a barrel, and could go lower, which is not exactly terrific news for oil companies and oil services concerns—particularly those who have invested in fracking production. But cheaper energy IS good news for manufacturers and consumers, which is sometimes forgotten in the gloomy forecasts. Chinese stocks and the Chinese economy are showing more signs of weakness, and there are legitimate concerns about the status of junk bonds—that is, high-yield bonds issued by riskier companies with high debt levels, and many developing nations. These bonds have stabilized in the past few weeks, but another Federal Reserve interest rate hike could destabilize them all over again, leading to forced selling and investors taking losses in the dicier corners of the bond market.

If you can think above the shouting and jostling toward the exists, you might take a moment to wonder about some of these panic triggers. Are oil prices going to continue going down forever, or are they near a logical bottom? Is this a time to be selling stocks, or, with prices this low, a better time to be buying? Are China’s recent struggles relevant to the health of your portfolio and the value of the stocks you own?

And what about the RBS analyst who is yelling “Fire!” in the crowded theater? A closer look at Mr. Roberts’ track record shows that he has been predicting disaster, with some regularity, for the past six years—rather incorrectly, as it turns out. In June 2010, when the markets were about to embark on a remarkable five year boom, he wrote that “We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable,” he added, ominously.   (“The unthinkable,” whatever that meant, never happened.)

Again, in July 2012, his analyst report read, in part: “People talk about recovery, but to me we are in a much worse shape than the Great Depression.” Wow! Wasn’t it scary to have lived through, well, a 3.2% economic growth rate in the U.S. the following year? What Great Depression was he talking about?  Taking his advice in the past would have put you on the sidelines for some of the nicest gains in recent stock market history. And it’s interesting to note that one thing Mr. Roberts did NOT predict was the 2008 market meltdown.

Since 1950, the U.S. markets have experienced a decline of between 5% and 10% (the territory we’re in already) in 35.5% of all calendar years—which is another way of saying that this recent draw down is entirely normal. In fact, our markets spend about 55% of the time in this range (pulling back).  One in five years (22.6%) have experienced draw downs of 10-15%, and 17.7% of our last 56 stock market years have seen downturns, at some point in the year, above 20%.

Stocks periodically go on sale because people panic and sell them at just about any price they can get in their rush to the exits, and we are clearly experiencing one of those periods now. Whether this will be one of those 5-10% years or a 20% year, only time will tell. But it’s worth noting that, in the past, every one of those draw downs eventually ended with an even greater upturn and markets testing new record highs.

Many investors apparently believe this is going to be the first time in market history where that isn’t going to happen. The rest of us can stay in our seats and decline to join the panic.

Without a doubt the market picture looks dour, and it’s hard to see red on our screens and declines on our monthly statements. A disciplined approach that takes into account your goals, risk tolerance and time horizon remains the best way to approach when and how you’ll sell. There’s always a better day to sell since strength always returns to markets after a panic. Your patience is always rewarded in the markets, though I acknowledge that it’s easier said than done. If investing in the stock markets was easy, then returns would not be anywhere near as rewarding as they are.

In our client portfolios, we continue to look for opportunities to add to positions in good funds and companies at the appropriate time. We continue to maintain a healthy cash position, and have increased our hedges. While we may see additional selling to start the week (which starts on Tuesday due to the Martin Luther King, Jr. holiday), I suspect that the selling is somewhat exhausted in the short term, so I’m expecting a robust bounce as early as this week (I saw signs of selling exhaustion on Friday January 15). The quality and duration of that bounce will tell us more about what’s to come, and whether more defensive measures are warranted.

Nothing in this note should be construed as investment advice or a recommendation to buy or sell any security. If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://finance.yahoo.com/news/why-the-heck-are-the-markets-tanking-165146322.html

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7857595/RBS-tells-clients-to-prepare-for-monster-money-printing-by-the-Federal-Reserve.html

http://www.publicfinanceinternational.org/news/2012/07/economic-crisis-%E2%80%98worse-great-depression%E2%80%99

http://blogs.spectator.co.uk/2016/01/the-author-of-the-rbs-sell-everything-note-has-been-predicting-disaster-for-the-last-five-years/

http://www.marquetteassociates.com/Research/Chart-of-the-Week-Posts/Chart-of-the-Week/ArticleID/140/Frequency-and-Magnitude-of-Stock-Market-Corrections

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Rate Hike Hype

While I’m still a tad skeptical, we will almost surely see the U.S. Federal Reserve Board (Fed) start the long process of ending its intrusion into the interest rate markets, by allowing short-term rates to rise starting on Wednesday. It will be the first time the Fed has raised rates since 2006, and for some it will mark the beginning of the final chapter of the Great Recession.

Since 2008, as most of us know, returns on short-term bonds have been at or near zero percent, which is a consequence of the Fed keeping the Federal Funds rate—the rate at which it will lend banks virtually unlimited amounts of money, short-term—at 0.125%. The average Fed Funds rate has historically been 3.5% to 4.0%, so this is a considerable amount of stimulus.

At the same time, the Fed has purchased more than $3.5 trillion worth of Treasury securities and home mortgage pools as part of its quantitative easing (QE) programs, bidding aggressively against much smaller buyers, which is another way of saying: forcing the rates on these bonds down closer to zero.

Pulling back out of these interventions is going to be tricky, in part because shifts in interest rates have a direct impact on a still-fragile U.S. economy (higher rates mean higher borrowing costs, potentially less corporate investment and lower profits), and even trickier because we don’t know how investors will react. In the past, the markets have panicked at the mere mention of a cutback in Fed involvement, and (more recently) have also risen on the same news, presumably because people drew encouragement from the confidence the Fed was showing in the strength and resilience of the U.S. economy.

There are also some tricky mechanical problems. The central bank will try to control the extent that short-term rates rise and fall by raising the interest it pays to banks for the reserves held at the Fed, and also cautiously raising the amount it pays money market funds for short-term trades known as “reverse repurchase agreements.” The mechanics are highly technical and complicated—and still unproven, although there are reports that the Fed has been conducting tests for the past two years.

As the markets react, either upwards or downwards, there are a few things to keep in mind. First, despite the headlines soon to be blaring from every financial section of every newspaper in the country, the rate is expected to move very modestly from .125% to .375%—clearly a small first step in a long journey toward the long-term average. After each step—prominently including this one—the Fed will evaluate the consequences before deciding to make future changes. If the economy slows, or if there are signs that inflation is falling below the Fed’s 2% annual target, it could delay the next move by months or even years. That caution greatly reduces the danger of any kind of serious economic pullback.

It’s also worth noting that the Fed has announced no plans to sell the nearly $4.2 trillion worth of various bonds—including the aforementioned Treasuries and mortgages—that it owns. At the moment, the bank is simply rolling over the portfolio, meaning it reinvests $21 billion a month as bonds mature. Eventually, most observers expect the reinvestment to stop and the Fed to allow the huge bond holdings to mature and fall off of its balance sheet. The fact that this is not being done currently reflects the exquisite degree of caution among Fed policymakers, who don’t want to rock the boat too fast or too hard.

Finally, some have wondered about the future of mortgage interest rates as the Fed begins a cautious exit from the bond markets. Interestingly, recent history shows that mortgages haven’t been especially influenced by changes in the benchmark rate. The last time we saw extremely low interest rates, after the tech bubble burst in the early 2000’s, the Fed brought its Fed funds rate down to 1%. It began raising rates by 0.25% a quarter starting in the summer of 2004, but over the next four months, the 30-year fixed-rate mortgage actually fell from 6.3% to 5.58%. By the time of the last increase in the summer of 2006, mortgage rates were running at 6.68%, just a half-percent higher than they had been at the previous Fed funds rate low.

Nobody knows exactly what to expect when the announcement comes on Wednesday, but you can look for the investment markets to bounce around a bit more than usual, and economists—including the teams employed by the Fed—to examine every scrap of data about the impact on the economy over the next quarter. At that time, Fed policymakers will face another decision, and there is no reason to expect them to be less cautious than they have been recently. For many of us, the rate rise should be reason for celebration, a sign that the long recession and period of economic uncertainty is finally starting—carefully—to be put in our rear view mirror.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

https://www.washingtonpost.com/news/where-we-live/wp/2015/12/14/what-a-fed-rate-hike-could-mean-to-mortgage-borrowers/

https://www.washingtonpost.com/news/wonk/wp/2015/12/14/the-federal-reserve-will-likely-raise-interest-rates-this-week-this-is-what-happens-next/

http://www.usatoday.com/story/money/2015/12/14/this-week-december-13/77155714/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Is America in Decline?

In 1945, the U.S. made up more than half of the world’s total gross domestic product (GDP), which basically means that half the world’s economy took place inside U.S. borders. Today that figure is just under 22%.

Does that mean America is in decline?

There seems to be a bull market in doomsayers these past few years, as we’re all reading arguments that the U.S. is slowly losing its grip on global preeminence. The rhetoric today sounds a lot like the hand-wringing back in the 1980s when Japan was allegedly taking over the global economy, and before that, when the Soviet Union had more missiles and a Sputnik circling over our heads.

There’s no easy way to define the overall quality of an economy, but probably the most thorough assessment comes out each year via the World Economic Forum’s Global Competitiveness Rankings. The most recent report ranked 144 countries around the world, including Qatar (16), Moldavia (82), Namibia (88), Lesotho (107) and the unhappy states of Chad (143) and Guinea (144), whose citizens eke out their lives on per capita incomes of $1,218 and $564 a year, respectively.

The survey looks at 12 “pillars” of economic competitiveness, including labor market efficiency, the quality of primary education and higher education, infrastructure, the strength of institutions, innovation, business sophistication, technological readiness and the sophistication of the financial markets. Each of these categories are broken down into dozens of subcategories, which are separately evaluated. For instance, when looking at the strength of each country’s public institutions, the World Economic Forum researchers consider whether people in a given country have strong property rights and intellectual property protection, whether there is corruption and the routine payment of bribes, whether the citizens enjoy judicial independence and a solid legal framework, and how well investors enjoy shareholder protection.

In the most recent survey, the U.S. ranked third overall, with an overall rating of 5.5 on a scale of 1-6. Ahead of it were Switzerland (5.7) and Singapore (5.6). China, the country that you most often hear cited as the all-powerful up-and-coming economy, ranked 28th, two rungs below Saudi Arabia, one rung above Estonia. Brazil and India, which are sometimes mentioned as powerful competitors to U.S. economic hegemony, are ranked 57th and 71st, respectively.

The point of the rankings is to show which countries have created the healthiest (or, in the cases of Chad and Guinea, the least-healthy) economic climate for future growth. But of course there are other ways of measuring competitiveness, including the bottom line (as mentioned at the top of the article) of percentage of the world GDP, and whether you’re moving up or down.

US and Global GDP through 2014

By that standard, the U.S. is indeed moving down. If you look at Figure 1 above, which shows the size of the overall global and U.S. economies since 1991, you see that the U.S. has enjoyed steady economic growth, while the world at large has essentially taken off like a rocket. The years following the collapse of the Soviet Union, when several billion people were suddenly allowed to become capitalists, have been good for world growth. When China shifted from a communist to a capitalist economic posture, this added fuel to the rocket. The democratization of computer technology and the global Internet has empowered value creators everywhere.

The U.S., Europe and Japan, in other words, no longer have a monopoly on capitalism. And that’s a good thing.

Is there a better way of evaluating how the U.S. economy is holding up in an increasingly competitive world? Figure 2 below looks at the first chart from a slightly different angle. Since 1991, what percentage of all the world’s business has been happening in the U.S., vs. Europe, Japan, China, India, Russia and Brazil?   How much of the total global economy did each nation claim in each year, and how has that balance changed over time?

US GDP Market Share through 2014

What you see there is that the U.S. is still in the lead by a pretty wide margin, and in recent years has actually stabilized its percentage of total global GDP. The decline has come mostly because a lot of smaller emerging markets, plus China and, to a certain extent, Brazil, India and Russia, have all been growing. At the same time, America’s traditional competitors—Europe and Japan—have been sinking. If you want to point a finger at decline, perhaps that’s a better direction than the U.S.

Does the U.S. face economic challenges? Of course. Is our political system a mess? Sure. Could things be better? Certainly. But if you sift through a lot of variables with a fine-toothed comb, you discover that the U.S. has created a better environment to grow and prosper than almost anywhere else, and it has held its own with the roaring growth of the emerging markets while the other developed nations are losing ground. More than a fifth of all economic activity still happens in the U.S., and the long, slow decline in that figure is not due to stagnation at home, but abundant growth all around the world. That’s not something to worry about; it’s something we should be celebrating.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://reports.weforum.org/global-competitiveness-report-2014-2015/rankings/

http://www.economywatch.com/economic-statistics/year/1990/

http://theamericanscene.com/2008/05/07/a-post-american-world

TheMoneyGeek thanks guest writer Bob Veres for writing this post.

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