Five Technology Behemoths

If you want to see, perhaps even enjoy, an exercise in futility, run a search in Google on this phrase:

2019 predictions about the stock market in 2020

As you’ll find, the search returns dozens of articles containing hundreds of predictions from market pundits about how they expected 2020 to unfold for the economy and the stock market. Some were bullish, some bearish. Some predicted a recession, others a continued economic expansion. Nearly all boldly predicted some “periods of volatility” for stocks – mostly due to 2020 being a presidential election year.

What you will not find in any of these articles is a single prediction that an unprecedented pandemic would shut down the world for months, tanking the global economy and sending the stock market down more than 30% in the span of just four weeks. Nor will you see any predictions of the historic recovery in stocks that followed.

To be fair, it’s hard to fault these failed fortune tellers from just 10 months ago. It wasn’t until December 31, 2019 that China first notified the World Health Organization of a mysterious, pneumonia-like virus emerging in the Wuhan region of China. It would be another month before U.S. health officials confirmed human-to-human transmission of the new virus. And it wasn’t until February 11 of this year that this novel coronavirus was given a name: Covid-19.

Yet, while we can’t blame any market pundit for their failure to predict the seismic impacts of a pandemic no one could have seen coming at the time – that’s also the point.

PREDICTIONS CREATE CURIOUSITY

In retrospect, predictions about the short-term direction of the stock market seem harmless enough. Whether they turned out to be right or wrong is little more than a curiosity. But in the present, when the future is a murky mystery, they have impact. We are bombarded with predictions from the so-called experts about the stock market on a daily basis, and in real time they often seem compelling. They are blasted constantly across web sites and news networks and into the consciousness of the investing public. Rightly or wrongly, many investors view these predictions as guidance; it influences their worldview, and, as a result, their decision making.

This dynamic was on full display in the midst of the stock market plunge in February and March of this year, when all the experts who didn’t predict the pandemic a few months earlier were rushing, undaunted, to issue new predictions. They warned of deeper market drops yet to come, and a plodding “u-shaped” recovery for stocks that would take years to climb out of once the bear market finally ended.

STAYING IN YOUR SEAT

Unfortunately, investors heeded these warnings and headed for the exits. According to Morningstar, Inc., they pulled $326 billion from mutual funds and ETFs in March – more than three times the amount of outflows the industry saw in October 2008. In the same month, investors plowed a record $685 billion into money-market funds – just in time for the massive stock rally.

It’s a story as sad as it is predictable, because we’ve seen it happen repeatedly in the past three decades. We can only hope that one day individual investors will finally realize how baseless these short-term market predictions are, and how much their net worth declines whenever they heed them.

It seems the rapid recovery in stocks since late March has been met with more skepticism than optimism. How could stocks have been on such a staggering upward climb since the early stages of the pandemic, with the economic impacts of the shutdown just beginning to be felt and the ultimate human impacts of Covid-19 far from certain? The rebound is generally attributed to stocks being propped up by the enormous relief packages enacted by Congress and accommodative fiscal policy from the Fed.

Indeed, there’s no denying that the stock market typically responds favorably to spending bills and easy money policies. But it’s also interesting to look under the hood, so to speak, and take a closer look at the stocks that have powered the S&P 500’s almost 50% gain since the market bottom on March 23.

As we saw through early July of this year, the S&P 500 index’s performance in 2020 has been heavily skewed by the 50 largest stocks in that index – and especially by the 10 largest stocks. Beyond that (as of the July date used in our analysis), the remaining 450 stocks in the index had negative returns, with the bottom 50 stocks down nearly 40% on average. It seems the index remains skewed in a similar state.

In fact, an even deeper dive into the S&P 500’s performance this year shows the rebound has been attributable to five technology behemoths: Amazon, Apple, Alphabet (Google parent company), Microsoft and Facebook:

Sources:  slickcharts.com and Yahoo Finance

Because these five stocks account for 22.6% of the S&P’s total market capitalization, their outsized performance has buoyed the index in 2020 despite the vast majority of its component stocks being in the red.

While the performance of those five big tech stocks has been impressive so far in 2020, they also carry significant risks going forward – namely in the stratospheric valuations these stocks now carry. As seen in the prior chart, the weighted average price-to-earnings (P/E) ratio of those Big 5 tech stocks was 50.1 as of August 10, compared to 22.2 for the remainder of the S&P 500. By comparison, small value stocks had an average P/E ratio of 12.20 as of June 30.

None of which is to say that any or all of these bellwether tech stocks are headed for a decline – just that their present valuations will require huge earnings going forward to justify their recent performance. Investors who are heavily concentrated in them are bearing the risk that comes with those lofty valuations – knowingly or unknowingly.

As always we are here to help.

Best,

CAM Investor Solutions

Source: Bloomberg; Slickcharts; Yahoo Finance; Morningstar, Inc.; Capital Directions; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Don't Just Do Something, Stand There!

Vanguard founder John Bogle once famously advised investors on how to handle stock downturns: “Don’t just do something,” he said. “Stand there!”

It is a wry and wise way of turning the conventional wisdom about what to do in bear markets on its head. When panic grips the stock market – as it did in February and March of this year – the gut instinct of investors is to do something. Sell. Flee. Run. Protect. Move. All of these survival instincts that lurk in the back of our brains during calm markets come rushing to the front when stocks swoon and we fear our financial security is in jeopardy.

The great irony of investing, though, is that our instincts are almost always wrong. Emotion is the enemy that leads us down stray paths and into a place of chaos and confusion. Creating a successful long-term investment strategy is all about process; it is a logical and methodical exercise that requires planning, prudence and discipline. And when our survival instincts kick in, our anxious brains don’t want to hear anything about planning or prudence or discipline.

Overcoming this urge to take action is made doubly hard by the endless stream of bad advice that permeates the airwaves and websites when the market plunges. The talking heads tell us to “take some money off the table” and “shift assets into defensive stocks” and various other bear-market tropes that are all just market timing masquerading as sound investment strategy.

The Importance of Having an Investment Philosophy

Alas, the majority of the investing public heeds this bad advice and flees the stock market for the perceived safety of bonds and cash, only to miss the ensuing recovery that occurs when everyone least expects it. We saw this vividly this past February, when U.S. equity funds saw $17.5 billion in outflows, while money-market funds saw $31.4 billion in inflows. (Source: Morningstar, Inc.). Predictably, and sadly, those investors were on the sidelines when stocks staged their dramatic turnaround beginning in late March. In a span of just 10 weeks, from March 23 to June 8, the Dow Jones Industrial Average gained a stunning 48.30%, but all of those investors who fled to cash missed out on the recovery.

Typically, these investors only dip a toe back into stocks when they perceive things to have calmed down. But by then the recovery has passed them by, and they only experience a long period of stagnant returns or, worse, another market downturn. This is known in the investment business as “getting whip-sawed” and it is all-too-common an experience for many investors. As a result, they conclude that the stock market is rigged or somehow stacked against them, ignoring the reality that it was their own behavior – not the stock market – that caused them to incur steep losses.

This wrong but widespread belief can be seen in numerous articles that have cropped up in recent months. One particularly egregious example we saw last week carried the headline, “The Stock Market is a Ponzi Scheme.” It pointed to various deceptions and frauds that have caused companies and investment products to fail, wiping out their shareholders in the process.

There is no denying that frauds and deceptions come and go in the financial markets. In the past two decades we have seen accounting frauds at WorldCom, Enron and several other huge conglomerates that have bankrupted the companies and wiped out their shareholders in the blink of an eye. Just in the past few weeks, a $2 billion fraud was revealed at Wirecard, a global payment processor, that sank the company and its stock.

The skeptics love to point to these unfortunate incidents as proving their assertion that the market is rigged and unfair to individual investors. What they fail to point out, though, is it was only the investors who were concentrated in these stocks who lost everything; for well-diversified investors, they were merely a blip on the radar, because the broad stock market isn’t impacted over the long run by the fates of individual companies. In fact, it is the nature of a free-market that companies are constantly coming and going within the ecosystem.

The buzzword in the start-up world these days is “disrupt” – meaning that small tech companies are seeking to disrupt larger, entrenched companies and industries that are vulnerable to innovative new technologies and strategies. Uber, Airbnb, and Venmo are but three of the more high-profile start-ups that have disrupted entire industries and the legacy companies within them. Meanwhile, venerable old-line companies with huge capital requirements such as Hertz and Neiman Marcus have filed for bankruptcy in recent weeks as their business models became unsustainable during the COVID-19 shutdown.

This dynamic of innovation displacing stagnation has been going on since free markets began; it should be embraced, not feared, because it is the fuel that propels the stock market ever higher in the long run.

Diversification is the way to capture those higher returns without betting on the fates of individual companies. And with an estimated 630,000 public companies in the world, there is simply no reason to take on that unnecessary risk.

Unfortunately, most investors don’t differentiate between market risk (the risk that is inherent to stock investing) and security risk (the risk you assume when investing a large sum in an individual stock or investment product). Market risk diminishes over time; the longer your holding period, the lower your risk of losing money. Security risk, however, does not. A company whose stock has outperformed the broad market for twenty years could still go bankrupt for unforeseen reasons and wipe out their shareholders in the process.

The Zoom Effect

We will close with a recent, and humorous, example of security risk. When the world went into shutdown-mode in March, video conferencing quickly became a part of everyday life for millions of people, and the phrase “Zoom call” became a part of our lexicon.

No surprise, then, that investors rushed to load up on the stock of Zoom Technologies. After all, if almost everyone is using a company’s product, it stands to reason the stock will soar, right?

And soar it did. Unfortunately for those who piled into the stock, it was the wrong company. Zoom Technologies was a penny stock that, according to regulators, hasn’t made a public disclosure since April 2015 and was last known to be operating in Beijing. Zoom Video Communications is the actual company these investors thought they were buying into. But, alas, the “fake” Zoom had the good luck to own the ticker symbol “ZOOM” and that was apparently enough due diligence for many people. Frenzied investors loaded up on ZOOM, sending the stock price soaring more than 2100% in just two weeks. Meanwhile, the stock of the “real” Zoom (whose ticker is the pedestrian “ZM”) gained a mere 50% during the same period of time.

So widespread was the confusion that the Securities & Exchange Commission finally felt compelled to intervene to save these poor investors from themselves, pausing trading in ZOOM on March 27. The regulator cited “the public interest and the protection of investors” as the reason for its order. But investors continued to pile into the stock when trading resumed, pushing it up a whopping 51,000% before the inevitable plunge to earth occurred in late April. Since that time, ZOOM stock has lost about 85% of its value – whatever that value may have actually been.

We are happy to report that real Zoom is alive and well.

As always we are here to help.

Best,
CAM Investor Solutions

Source: FactSet; Morningstar, Inc.; Capital Directions; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

How Fast The World Can Change

On February 12, the Dow Jones Industrial Average closed at an all-time high of 29,551. At that time, the economy was humming, corporate earnings were rising and unemployment was at lows last seen during the mid-1950s. While global health experts were increasingly worried about a potential pandemic caused by a new Coronavirus, it seemed to be something that was off in the distance. SARS, MERS and the 2009 Swine Flu pandemic had all run their respective course without derailing the global economy. The hope was that COVID-19 would as well.

Needless to say, things didn’t exactly pan out that way. In mid-February, health officials sounded the alarm that COVID-19 was coming to virtually every corner of the globe and would be difficult, if not impossible, to contain. Models from medical institutes were generated showing grim infection and mortality rates. Governments around the world responded by implementing extreme measures to combat the pandemic, shuttering all but essential businesses, canceling public gatherings of most any size, and ordering people to shelter in place for an extended, and undetermined, amount of time.

The combination of events effectively turned both corporate and consumer spending – the twin engines of global economic growth – to a trickle. This unavoidable and unexpected reality sent stocks into a tailspin so rapid that there was no historical precedent, even during the Great Depression. When the Dow reached its (thus-far) low of 18,591 on March 23, it represented the shortest period of time ever in which that index declined 30% or more from its peak.

Economists refer to developments such as the COVID-19 pandemic as “exogenous events” – unexpected and highly impactful events that are so far outside the bounds of normal expectations that they can’t be modeled. After a twenty-year time period in which we’ve seen 9/11, the Great Recession and the current pandemic, we feel we speak for most people when we say we’re getting a little tired of exogenous events.

As individuals, we are all grappling with the anxieties and uncertainties that the COVID-19 pandemic has ushered into our lives. On a purely investment level, however, we would like to share some of our thoughts that we hope will provide some perspective during this time of uncertainty.

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When the Dow fell to about the 20,000 level on March 17, the stock market at that point was pricing in an expectation of a 50% to 80% decline in corporate profits from the economic fallout associated with the pandemic (source: Brian Wesbury, Chief Economist, First Trust). By comparison, corporate profits fell 46% in 2008, a time when the global financial system was on the brink of collapse. Being forward-looking, the stock market has already priced in a drop in corporate profits as bad or worse than anything we saw in 2008. So, while the market may well decline below its recent lows, it is hard to argue that it hasn’t already factored in a major economic downturn.

Should that dire scenario fail to materialize, we would expect a rapid rebound in stocks as the market quickly reprices itself for expectations of higher corporate profits. That repricing may (or may not) already be underway in light of the significant gains stocks have posted since the Dow reached its recent low on March 23. Since that point, the Dow has seen two historically large moves upward, and a lot of volatility in between. The first big move was on March 24, when the Dow gained more than 11%, the largest one-day percentage gain for that index since 1933. The Dow continued upward for the next two trading sessions, at the end of which it had soared more than 21% in just three days. If you’re keeping score at home, that effectively ended the official bear market that had begun on March 11, when the Dow closed 20% below its February 12 record high. It may be semantics when we look back on this down the road, but it was the shortest bear market in history. Stocks then bounced around in late March and early April before another big move upward April 6-8, when the Dow gained 11.23%.

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The pundits love to dismiss these sudden upward moves in the stock market as “fake bounces.” They say they are but mirages, temporary upward climbs on a long, painful slog downward. They may well be right; only time will tell. But one thing we know for certain is that they don’t know anything more than you or us about whether the market truly hit bottom on March 23 or whether there is more in the downturn yet to come.

“Fake” bounces are indeed common occurrences during times of extreme market volatility. We saw many of them during the Great Recession in 2008-09. But the thing is, sooner or later that bounce will turn out to have been real, and we will only know it with the benefit of hindsight. A great example of this was when the Dow bottomed out at 6,469 on Friday, March 6, 2009. You may recall that, at that time, there was no good news to be had. The foundation of the global financial system was still quaking, unemployment was soaring, and stock investing was derided as a fool’s errand.

The conventional wisdom of the day was that we should not expect a v-shaped recovery in stocks, but more of a u-shaped one in which we slogged along at the bottom for months or years. An unnerving headline in The Wall Street Journal the next Monday read: “Dow 5000? There’s a Case for It.” Let the record show that this was the exact date the bear market ended and stocks took off; a decade later the Dow was at 25,650.

When the market does reach its bottom and the current downturn ends, investors on the sidelines who have been awaiting the all-clear signal will be in for a rude awakening. Stocks do not send out announcements when they change course, and the news environment is often deeply negative when they do. For example, when stocks began their turnaround in March 2009, they did so with breathtaking speed. Here is a graph showing the cumulative gains logged by a variety of market benchmarks from March 10, 2009 to December 31, 2009 (remember that these are indexes, not actual investment products; past performance is not an indication of future results):

In a span of less than nine months, stocks across all sectors posted gains that often take a decade or more to achieve. The pundits were there every step of the way to warn us that this was yet another fake bounce. But it wasn’t, and investors who heeded the bad advice missed out on crucial gains that those who stayed invested enjoyed.

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We are all feeling a lot of empathy these days for the economic pain that the shutdown is inflicting on millions of people. When we dare to venture out of our homes to make a dash into a grocery store or pharmacy, we all see the same thing: mile after mile of businesses shuttered and parking lots emptied. We ache for the owners of the businesses in our own neighborhoods, many of whom we know and care about, and wonder if they will be able to survive. It’s tempting to extrapolate what we see with our own eyes to the larger investment picture. With so many businesses – even publicly-traded ones – likely to fail, how can we have confidence in investing in stocks?

This is where it’s important to remember that our investment philosophy at CAM Investor Solutions is grounded in the belief that we should invest in markets, not individual companies. We construct our portfolios so that every client has broad exposure to thousands of companies. Inevitably there will be winners and losers in the months and years ahead. As we saw in 2000-02 and again in 2008-09, there will be high profile, household-name companies that fail. But there will also be winners that come out of the aftermath, companies that are well positioned and able to pivot to take advantage of the new economic environment. New companies will come out of nowhere and bring vital new products and services to the world and thrive because of it.

In the long run, stock returns are a reflection of the future expected earnings and the cost of capital for public companies. When we employ a broadly diversified portfolio strategy, we are effectively letting the free market sort out the winners and losers while we capture the long-term benefits of stock investing.

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We are not typically fans of Jim Cramer’s shock-jock approach to stock investing on his CNBC show, but he did raise a point recently that resonated with us.

“If you’re short (i.e., betting against the market), you’re betting against science,” he said on March 27. His point was that scientific innovation is an incredible tool for solving seemingly insurmountable problems, and assuming the current Coronavirus pandemic will go on without any solution to it is, well, a rather dim view of human ingenuity.

With that, we wholeheartedly agree. And the point is valid well beyond the realm of science. Consider that, for the first time in human history, the world is collectively focused on solving a single problem. Right now, there are 7.5 billion people on this planet who are all anxious to see an end to this pandemic as soon as possible. Scientists, engineers, executives, entrepreneurs, politicians – everyone wants an answer to the Coronavirus crisis.

This unified desire has provoked an unimaginable deployment of the world’s resources to the crisis. In just the span of a few weeks, we have seen the following response to a virus that has only been known since late December:

Over 52 potential vaccines submitted for review to the FDA and other global health organizations.

Testing kits that are being produced in the millions to detect both current infections and prior exposure to the Coronavirus. This will provide vital knowledge to understanding how widespread the virus is and when the world can get back to work.

Assembly lines at Ford and General Motors converted to manufacturing ventilators.

Cruise ships converted to hospital ships.

Breweries converting their fermentation tanks to make hand sanitizer.

Apparel companies converting their production lines to manufacture masks, face shields and gloves for healthcare workers on the front lines.

Corporate jets being used to transport critical supplies to the most affected areas at no charge.

We could go on and on, but the point is clear. Human ingenuity is a vast and incalculable resource and it is being put to use on a single problem like never before. In times of crisis, it can be difficult for investors to put their faith into solutions that haven’t emerged yet. But we can look back over the course of history and see that human ingenuity has seen us through every crisis we have ever faced. We are confident it will see us through this crisis as well.

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As wealth advisors, we are – first and foremost – in the relationship business. Building trust and rapport with our clients is vital to helping us understand their needs and achieve their goals. It’s something that happens organically over time; along the way, we get to know our clients and our clients get to know us.

All of which is to say, our relationship with each of you means a lot to all of us at CAM Investor Solutions. Financial events – market declines, recessions, etc. – can be difficult times for investors. But a pandemic brings a different type of anxiety altogether. All of us worry about how the people we know and care for will be affected by this, both from a health perspective and an economic perspective.

If there is any silver lining in all of this, it’s that this crisis has honed all of our priorities and deepened our appreciation for the people we care about. Please know that we are here for you in this trying time, both as advisors and as friends. If you want to discuss your financial situation, of course, we are always available for that. But if you just want to vent, be reassured, or just generally have some human connection while we are all feeling housebound and isolated, please pick up the phone (or send us a Zoom meeting invitation!) and we will be there for you. And if there is anything we can do to assist you or a loved one who is in need, please know that we will be happy to help in any way we can.

Best,
CAM Investor Solutions

Source: Index data from Bloomberg, Dimensional Fund Advisors, and Capital Directions; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Should I Be Buying or Selling Stocks Now

It seems investor sentiment has quickly changed since the beginning of the year, not to mention from just about 10 days ago as witnessed by the recent stock market decline. Many argue "why" this has happened and here's a quick look at the potential reasons:

Coronavirus: Most argue this is the primary reason for the recent market sell off. Its certainly terrible what is happening across the globe to humans who are suffering or have passed away. Our hope is that we have containment and a cure soon.

Presidential Election Uncertainty: Others will point to the future expectation being priced in on who will win the next election based on recent debates. We won't go here, especially because the market will figure it out faster and price it in before any of us can profit from the future results.

"We were due for a correction"Always a classic reason for market sell offs, especially coming off all-time market highs just a couple of weeks ago.

Insert your own "crisis of the day": We are adding this one in advance of what will happen in 2020 and beyond. We don't know what the next crisis will be or when, but its highly probable that it will be something we can't control or predict.

Who should be concerned? Its simple: those who have not put a good financial plan in place. For those of you who have taken the time to establish a well thought out financial plan, you've been planning for short-term market fluctuations like this which will have no impact on your current or future lifestyle. For the latter audience, it is also probable that you and/or your advisor are rebalancing your portfolio given the opportunity. This is how risk is properly managed and how investors build a larger nest egg over time. It is also what we call investor discipline, but we know its not always easy to watch depending on your stage of life.

Chart end date is 12/31/2019, the last trough to peak return of 451% represents the return through December 2019. Bear markets are defined as downturns of 20% of greater from new index highs. Bull markets are subsequent rises following the bear market trough through the next new market high. The chart shows bear markets and bull markets, the number of months they lasted and the associated cumulative performance for each market period. Results for different time periods could differ from the results shown. Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

In light of recent investor questions, market volatility, lower interest rates, and lower inflation expectations, we thought we would leave you with some additional food for thought as you might be considering rebalancing and/or different investment strategies going forward. And of course beware of those trying to sell you the "guaranteed" products that are not a fit. These folks seem to be everywhere at a time like this.

Investment Strategy Considerations/Risks:

PASSIVE FIXED INCOME

Many investors use the Barclays Agg as a proxy for the fixed income universe. The Barclays Agg has no TIPs, 28% of the index is short volatility and 32% has credit spread risk. Some larger, well-known mutual funds hold this type of risk.

REAL ESTATE

While rates are extremely low, any jump in higher rates increases the all-in cost of buying a home or other property, which can depress demand. Increased rate volatility can reduce mortgage lenders' appetite for new loans.

MINIMUM VOLATILITY / LOW VOLATILITY STOCKS

Min vol / low vol stocks can be seen as "defensive" and used with the goal to generate yield with less equity risk than the broader market. However, investors might be overpaying for "safe" stocks. These stocks have nothing to do with owning "volatility".

SHORT DURATION BONDS / TIPS

TIPS are set using the Consumer Price Index (CPI), which only represents today's inflation level.

FLOATING RATE NOTES (FRN)

Frequently used to profit from higher yields, FRNs may have credit risk and almost no sensitivity to interest rates. Currently 91% of the bonds trading in the Bloomberg Barclays Floating Rate <5 Year Index are trading above par.

PRIVATE ALTERNATIVE INVESTMENTS

While some private alts may serve as a good diversifier, caution is recommended as most strategies in this arena perform just like the stock market with a lag in reporting. Not to mention, most are super expensive, over-leveraged, and illiquid.

EQUITIES / GLOBAL STOCKS

Global Equities are a very efficient and low cost way to gain exposure to the capital markets. They can also serve as a way to keep pace with inflation over time. Given their risk/return characteristics, global equities are subject to market sell-offs due to deteriorating economic conditions.

Of course, there is a lot more to consider given investor needs, circumstances, and risk tolerance. Having a well-designed plan can address most all of these concerns and uncertainties. 

As always, we are here to help.

Cheers,

CAM Investor Solutions

Source: S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved; Bloomberg; Dimensional Fund Advisors; Nancy Davis, Quadratic Capital Management, LLC; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

The Great Market Plunge of 2019

It was in this letter exactly a year ago that we sought to provide some perspective about the steep decline stocks had just experienced in fourth quarter 2018. Over the course of just a few trading sessions in December, the Dow Jones Industrial Average declined 12%, and the Russell 2000 small stock index fell 14%. The plunge sent the major market benchmarks into bear market territory (defined as a decline of 20% or more) for the first time in a decade.

The anxiety in the market was apparent heading into 2019. Despite that, we urged calm and caution:

The thing about moving to the perceived safety of less volatile investments like bonds and cash during a downturn is that, once the dust clears and the market turns up again, it usually turns up in a big way. Much of the recovery happens before most investors realize it, and big gains that were there for the taking by those who are fully invested are missed by those sitting on the sidelines.

-- CAM Investor Solutions client letter, January 2019

As it turned out, that is exactly what transpired in 2019. Stocks across the globe went on a tear, posting gains well into double-digits. All of the damage done by the 2018 bear market was wiped away as market benchmarks closed 2019 at or near record highs:

This isn’t to suggest that we had any divine insight about when stocks would recover. Sometimes bear markets come and go quickly, as this one did. Sometimes they are plodding and protracted, as the 1973-74 bear market was. And sometimes they are unnerving and traumatic, as the 2008-09 bear market proved to be.

The one constant in all of these examples, though, is that they all ran their course over time. There has never been a bear market that didn’t end eventually, and invariably the market surges upward when the dust has cleared. That’s what happened in 2019.

Predictably, the market doom-and-gloomers have changed the narrative and now are trying to convince us that stocks are too high. They point to the fact that the Dow has climbed from 6,470 in March 2009 to its present level (as of this writing) north of 29,000. Given that, it’s easy fodder for the talking heads to make the case that stocks are destined for a downturn.

It’s interesting, then, to look at the stock-market performance of this past decade compared to prior decades. When we do, we find that the strong performance of the 2010s was hardly out of the ordinary:

Clearly, the strong performance of stocks in the past decade doesn’t necessarily portend a big downturn on the horizon. But still the doom-and-gloomers appear on our TV screens and on our apps and computers to warn us things are just about to fall apart. Whether they are economists, hedge-fund managers, or former government officials, these perma-bears all sing from the same side of the hymnal: Something is fundamentally wrong with the economy/financial system/stock market and imminent doom awaits us all.

Interestingly, a recent study finally took some of the more high-profile perma-bears to task. The study dubbed them the “Armageddonists” and took a look at what the impact on a dollar would have been during the 2010s if an investor followed their advice to flee stocks and move to bonds:

The damage done to an investor who followed the Armageddonists’ advice is staggering. Even the “best” performer of this group saw a 25% underperformance compared to the S&P 500. Most of the group saw underperformance in the range of 30% to 60%.

Alas, this is not anecdotal. Individual investors have proved susceptible to the Armageddonists time and time again, and 2019 was no different. Individual investors fled stocks in droves throughout 2019, even as stocks surged upward along the way. A December article in The Wall Street Journal reported that:

Investors have pulled $135.5 billion from U.S. stock-focused mutual funds and exchange-traded funds so far this year, the biggest withdrawals on record, according to data provider Refinitiv Lipper, which tracked the data going back to 1992…Investors have put roughly $277.2 billion into U.S. bond funds so far this year, the third biggest sum over the past decade, while $482.8 billion has flowed into money-market funds, an 11-year high, according to Refinitiv.

-- Investors Bail On Stock Market Rally, Fleeing Funds at

Record Pace, The Wall Street Journal, December 8, 2019

It's both predictable and sad that individual investors react this way to market volatility. There’s little rational thought behind such behavior; it’s all based on emotion – specifically fear – as they become overwhelmed with negative information and opinions, much of it designed to spur exactly that kind of panicky behavior.

These are the dangers of letting emotions and hunches drive your investment strategy. What do investors who fled stocks in 2019 do now in 2020, with stocks back near record highs? If they jump back into equities and happen to catch another downturn, they will have essentially double-dipped on the downside. And if they wait until the next downturn comes, they will more than likely convince themselves, yet again, that such a downturn is no time to be investing in stocks. This is the dilemma of market timing – never knowing what to do and always being afraid you’ll make the wrong move no matter the market environment. It’s no way to manage an investment portfolio, and it may be a path to financial disaster. The better path is to let your financial plan drive your investment strategy.

As always, we are here to help.

Best,
Marc

Source: LPL Research; Bloomberg; Ned Davis Research; Axios Visuals; JP Morgan Asseet Management; Capital Directions, LLC; Wall Street Journal December 8th, 2019 "Investors Bail on Stock Market Rally, Fleeting Funds at Record Pace"; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Don't Just Sit There - Do Something

It has been said that golf is an easy game, it’s just hard to play. Much the same could be said of investing.

The principles of long-term investment success aren’t particularly complicated. Construct a well-diversified portfolio appropriate for your risk and return needs. Stay the course and let compounding work its magic over time. Easy, right?

And yet…it isn’t. Emotions get the better of investors. Fear and greed are constantly whispering in their ear. They worry about the downturns and second-guess themselves in the upturns, wondering if they are doing the right thing. They can’t avoid the temptation to make “adjustments” and “tweaks” to their portfolio based on short-term market trends. They sit on cash that should be invested, worrying that the market is too high or too low.

Avoiding these temptations is made infinitely more difficult in our modern world. Every time investors pick up their phone or turn on the TV, they are bombarded with a firehose of information, much of it worrisome. The spin may change depending on the day, but the underlying message from the “experts” is always the same: Don’t just sit there – do something!

This message seems to peak whenever October rolls around, and we are seeing it again this year. Stories abound about the so-called “October Effect” – the (supposed) tendency for stocks to experience declines more frequently and more severely in October than the other months of the year. The pundits make competing predictions about which sectors investors should overweight or underweight and how much cash to raise to protect against a downturn.

These pundits might find it an inconvenient truth that October isn’t the worst month historically for frequency of stock declines; that distinction actually belongs to September. What is true about October is that it is historically the most volatile month of the year and has a higher standard deviation than any other month on the calendar. Given that three of the biggest stock-market percentage declines of all time have occurred in October (1929, 1987 and 2008), it isn’t a big surprise that investor anxiety rises when the pumpkins hit the stores. The historical spike in volatility in October is a reflection of that anxiety. 

But even accepting that October is historically the most volatile month of the year for stocks, the question remains: What should long-term investors do with that information?

There are two important things to keep in mind about volatility, regardless of how October 2019 – or any other month – plays out for stocks:

Volatility is a necessary component of stock investing

Investors demand more upside when they take on more risk. Cash has lower volatility and therefore lower expected returns than bonds. Bonds have lower volatility and lower expected returns than stocks. Large stocks have lower volatility and lower expected returns than small stocks. And on and on. There is simply no way around the risk/reward equilibrium. Risk and return are related. If volatility wasn’t an inherent part of stock investing, investors wouldn’t reap the higher expected returns that stocks generate over bonds and cash. While living with the short-term ups-and-downs that are a part of stock investing isn’t fun, it is the medicine we must take to obtain the higher long-term returns we will need to protect our purchasing power against inflation.

Volatility becomes much less of a factor over time

If the price of your house declines by 20%, do you rush to sell it before the value drops even more? Most homeowners would never take such rash action, and yet every time the stock market goes into a steep decline we see large numbers of equity investors run for the exits. Some of this is attributable to the liquidity of stocks compared to real estate; it isn’t possible to bail out of your house at the push of a button, but it is possible to do that with your stock portfolio. But it also speaks to the lack of a long-term view many investors have about stocks. Homeowners expect to be in their houses for the long term and don’t worry about the short-term fluctuations, but they don’t take a similarly sanguine view with their stock portfolio.

After the market crash of October 1929, the Dow Jones Industrial Average stood at 230. The Dow fell to a level of 1,738 after the October 1987 plunge, and it fell to 8,451 on October 10, 2008 after the initial selloff during the Financial Crisis bottomed out. And yet here we are today, with the Dow (at present) hovering around the 26,000 level. The undeniable reality is that stocks have overcome every downturn they have ever experienced – given enough time.

Alas, while stock volatility isn’t an issue over the long run, most stock investors don’t stay invested long enough to let it runs its course. The 2018 Quantitative Study of Investor Behavior by Dalbar & Associates found that the average holding period for an equity mutual fund from 1998-2017 was just 3.55 years! There is a significant opportunity cost that investors – especially taxable investors – incur when they constantly move their money from fund to fund, or in and out of the market. Transaction costs, taxes and just plain bad guessing all add up to deny investors the returns that were there for the taking if they had just stayed put. We can see the cost of this behavior in the following chart comparing the average annual returns of equity-fund investors to the S&P 500 over the past decade (source: Dalbar & Associates QAIB Study 2018):

It is a sad reality that the average equity-fund investor attained the equivalent of bond-fund returns over the past decade. Clearly, behavior is a major component of investment success and is the one factor that gets the least amount of attention. This is why having a disciplined investment management plan and sticking to that plan regardless of short-term market conditions will have the biggest impact on your long-term wealth.

To take it a step further, if you have a well thought out financial plan in place or have established a very efficient retirement income strategy, then all the short-term noise should have no impact on you. This is because you have already planned for market volatility, recessions, and bear markets due to how you are managing risk. You likely also understand how to get properly compensated for taking the right investment risks.

If you don't have a good plan in place (above and beyond just picking investments), it may be time just to give you a little more confidence and conviction as you tune out all the noise. As always, we appreciate our relationship with you, and we are here to help.

Cheers,

Marc

Source: Dalbar & Associates QAIB Study 2018; Capital Directions, LLC; M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Has a Global Recession Arrived

Some claim that a global recession has begun following a lot of the recent economic data. Others might argue that major problems only exist overseas, and signs of any recession is not present in the United States.

Regardless of who is right, we expect a recession won't be confirmed until twelve months or longer after the fact. This is similar to what we've seen in the past and is usually confirmed by the National Bureau of Economic Research (NBER) as well as other sources. The challenge is that predicting a recession is harder than you think.

INTEREST RATES

A lot of this debate and investor concern has been fueled by the recent steep decline in interest rates and does deserve further attention. Many of you may be wondering what happens if we experience zero or negative interest rates in the future? To be blunt, nobody knows with certainty what will happen because we've never experienced such an environment in the United States. It's also expected many "experts" will pretend they know what will happen and we recommend investors use caution around those who provide this kind of advice. Just remember, interest rates can increase too which many seem to forget.

As many of you know, our firm uses facts, logic, and an evidence-based approach to financial planning and investing. Instead of trying to forecast or "guess" future events, we look to focus on what we know to be true as well as seek to provide our clients with a higher probability of success. In our recent blog A Stock Market Cycle and Investor Discipline, we highlighted interest rate yields and inflation expectations are at generational lows. Given this current environment, we address several investor questions below that relate to the possibility of zero (or negative) interest rates including considerations for the next recession:

If we anticipate a recession is coming, should we get out of the stock market and go to cash and bonds? No. If you have a good financial plan in place that is properly managing investment risk and liquidity, then you should have been planning for market volatility (or you would have been 100% in the stock market). Also, some bond strategies may carry more risk than you think even though they are deemed to be safe.

Aren't my treasury bills (T-bills) safe in a recession or low-rate environment? Yes, the principal value for individual issues is guaranteed, however, T-bills are not immune to inflation. There are other solutions to accomplish this.

Should we continue to expect low inflation? By traditional measurements, inflation is at generational lows in the United States. However, if you look closer it is present in the economic data and in the goods and services we buy every day. Should tariffs continue, this is expected to also push up inflation pressures.

Should I sell all my fixed income if rates go to zero? Probably not all, but yes, it's possible some of the longer duration or higher risk bond funds may no longer offer appropriate compensation for risk. Fixed income has had a historic bull market given declining rates. At these levels it seems reasonable to expect most fixed income will produce lower returns going forward and some of these strategies may also bear greater risk if rates reverse course and increase. Hence, some holdings may warrant selling and rebalancing into higher quality, short-term duration funds which should still provide ample liquidity, but be less sensitive to interest rate fluctuations. In terms of individual bonds, their yield to maturity or yield to worst should not be impacted.

Given the risk of recession and interest rate fluctuations, will this hurt my real estate investments? Not necessarily as it depends on what sector of real estate (public vs. private; residential vs. commercial, etc.). Also, if short-term interest rates began to rise, it doesn't mean this will be bad for the sector.

Are there any fixed income strategies to consider that are not tied to interest rate fluctuations? Yes, some exist such as alternative lending, private debt, and inflation protection strategies. However, it is important to evaluate if these are appropriate in the context of one's risk tolerance and asset allocation.

Should I still hold as much cash if rates keep dropping? Any good financial plan will always retain a healthy amount of cash for emergency reserves, essential living expenses, and other needs. This level of liquidity avoids having to sell or realize losses in a down market or tough recessionary environment.

Given recession risks, should I reallocate into alternative investments? While some alternatives may offer diversification benefits for certain investors, many of these solutions will still feel the pain and impact of weak economic activity and recessionary periods. In particular, many private alternatives don't price each day or will experience a lag in reporting. Lack of liquidity is often an issue too for many private alternatives during a period of distress.

Should I own individual bonds or bond mutual funds? Potentially both, especially if rates continue to fall further.

How long should we expect low interest rates? There is a lot of research that suggests the best predictor of future rates are today's interest rates. So, it's possible low rates may continue for some time.

What is the impact of a long-term, low rate environment? Its positive for those looking to borrow, refinance, structure businesses, debt, and many other common financial needs. For income investors, it may present a challenge to generate enough income due to lower yields. It also seems reasonable to expect that traditional fixed income returns will be lower in the future compared to the past twenty or thirty years. This will impact financial planning and retirement income expectations for some. A low-rate world may also decrease future stock market returns which was a critical discussion that we covered earlier this year in The 60/40 Investment Debate.

For investors who have a sound financial plan in place and are properly managing risk, most of this discussion should have no impact on you. However, a second opinion never hurts.

As always, we appreciate our relationship with you, and we are here to help.

Best,
Marc

Source:  J.P. Morgan; Federal Reserve Bank of St. Louis; Dimensional Fund Advisors; Bloomberg; Stone Ridge Asset Management. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

A Stock Market Cycle and Investor Discipline

Every point in a stock market cycle brings its own emotional challenges for long-term investors. When volatility spikes, as it did in 2018, investors need to muster their intestinal fortitude and avoid the temptation to flee to cash. In times of extended market doldrums, as we saw in 2015-16 when stocks mostly moved sideways, investors must avoid the temptation to go looking for higher returns in risky investments that can lead to big losses.

Then there is the environment we currently find ourselves in – with most major market indices at or near all-time highs. When stocks push into record territory, no one other than short sellers are unhappy. Real Estate continues to look unstoppable as well. It is also worthy to note that interest rate yields and inflation expectations are at generational lows.

Source: Federal Reserve Bank of St. Louis, FRED Economic Data Period: January 1, 1964 to March 31, 2018; Source: Illuminating the Path Forward, Ross Stevens, Joshua Zwick, Randolph Cohen, February 2017, p 5.

But the enthusiasm is often tempered with anxiety about stocks being overvalued and poised for a fall. These fears are only enhanced by the endless stream of stories in the financial media highlighting analysts’ predictions of a looming downturn. These stories are often accompanied by suggestions that investors should “take some winnings off the table” and pare back their stock exposure. We even discussed some related concerns in a recent blog The 60/40 Investment Debate.

To better understand how long-term investors should view the future direction of the stock market, it’s helpful to revisit the past. A look back at some of the major milestones the Dow Jones Industrial Average has achieved through the years is insightful.

The Dow first closed above the 1,000 threshold in 1972. It cleared 2,000 in 1987, closed above 5,000 in 1995 and hit 10,000 for the first time in 1999. Several times along this journey, the Dow failed to hold its ground when it reached a milestone and pulled back. Stocks entered a long bear market in 1973 and struggled to emerge from it for the rest of the decade. The Dow also spent much of the 2000s trying to hold the 10,000 level, only to fall back during the bear markets of 2001-02 and 2008-09. But the Dow also frequently blew through other milestones without looking back, notably during the mid and late 1990s, as well as in recent years. The below chart for the period from 1995 to 2017 highlights the journey to new milestones for the Dow:

Source: CBS Marketwatch research

The bottom line is that stocks hitting record highs and major milestones is not a clear indicator that a downturn is looming. Stocks can, and often do, keep soaring well after the conventional wisdom has decided equities are overvalued. And even if a downturn occurs, they are often temporary and shouldn’t dissuade long-term investors from putting money to work in the stock market. Of course, trying to predict market events in advance with long-term success is impossible. However, we do understand the importance of proper risk management and believe everyone should have a custom financial plan in place that is aligned with their investment strategy. This not only helps achieve one's goals, but can provide a better way to protect their financial health for both their current and future needs. 

As usual, the Oracle of Omaha, Warren Buffet, had some keen insight on this topic. At a Forbes magazine conference in 2017, Buffet scoffed at those who are bearish about the future performance of the U.S. stock market. “Being short America has been a loser’s game, and I predict to you it will continue to be a loser’s game,” he said. He then made a prediction that the Dow would reach the 1,000,000 level within a century.

At first glance that seems incredibly bullish on Mr. Buffet’s part, but it’s worth noting that it would only require a 4% average annual gain in the Dow to reach the 1,000,000 milestone in a hundred years. And that’s really the whole point we are making: stocks are always plowing ahead, though rarely on a straight line. But the climb through record highs and major milestones is an inevitable part of the stock market’s nature, and those investors who let fears of stocks being “too high” are the ones who won’t be along to enjoy the ride.

A bit of esoteric-but-still-interesting research crossed our desk this quarter. The research firm TS Lombard conducted a study in which they separated out the returns generated in the S&P 500 from domestic (U.S. based) investors vs. the returns generated by overseas investors. The study covered the period from January 1, 2017 to April 24, 2019, and the results were striking.

The study found that nearly all of the 30% gain in the S&P 500 during that time period came outside of U.S. hours. When the U.S. exchanges were open, the S&P gained a mere 2%, with the rest of the gain coming after U.S. exchanges had closed. The spread was especially striking since the beginning of 2018, with the S&P 500 actually experiencing a 5.4% decline during U.S. trading hours, yet still posting a 9% gain for the period thanks to the bullishness of overseas investors.

So what can we glean from this research study? To us, it seems clear that overseas investors in U.S. stocks are focused much more on long-term fundamentals than they are on the short-term news cycle. Stocks in the U.S. tend to be more volatile while the U.S. exchanges are open because American investors are immersed in all the short-term noise surrounding the markets. How often have we seen the Dow plunge 100 points or more over a news report that momentarily panics the market, only to fully recover the next moment when the report proves false or less dire than initially believed?

While news about the U.S. certainly doesn’t end at our borders, it’s logical to assume that overseas investors aren’t as obsessed with every iota of new information that comes out during the U.S. trading day and are instead focused on finding the best investments for their money. And U.S. stocks have proven, time and again, to be an outstanding long-term investment.

Something to keep in mind the next time irrational anxiety grips the market and sends investors scurrying to hit the panic button.

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

Source:  Forbes; J.P. Morgan; Federal Reserve Bank of St. Louis; Bloomberg; Stone Ridge Asset Management. M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. As a fee-only firm, we do not receive commissions nor sell any insurance products. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. This blog has been provided solely for informational purposes and does not represent investment advice or provide an opinion regarding fairness of any transaction. It does not constitute an offer, solicitation or a recommendation to buy or sell any particular security or instrument or to adopt any investment strategy. Any stated performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. Charts and graphs provided herein are for illustrative purposes only. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Are Investors Missing the Big Picture

After a turbulent end to 2018 sent stock indices around the globe into bear market territory, equities staged a big recovery in the first quarter of 2019. For the quarter, the S&P 500 index gained 13.65% and was within a few percentage points of its record high. The Russell 2000 small stock index gained even more, rising 14.58%. Large cap foreign stocks, emerging markets stocks and REIT (real estate) stocks all enjoyed robust recoveries as well.

Alas, the many thousands of investors who bolted the market in December weren’t along for the ride. 

As markets swooned in December, according to Lipper, investors pulled $98 billion from U.S. equity funds, most of it coming late in the month after the steep selloff on Christmas Eve. The outflows weren’t just limited to stock funds; Morningstar estimates bond funds saw net outflows of $43 billion in December as investor anxiety about rising interest rates drove them to flee fixed income. Meanwhile, money-market funds saw their largest inflows since 2008, with a net $162 billion moving into that category in 2018.

In that regard, it should come as no surprise that stocks and, to a lesser extent, bonds saw a big rebound to start 2019. Individual investors have a long, sad history of doing exactly the wrong thing at the wrong time with their money. The events of the past six months have proved no exception.


To be sure, more rational investors didn’t head for the exits in December; after all, a 20% decline in stocks is hardly unheard of. But every investor has moments in their life when emotions overwhelm rational thought. We call these times “blink moments,” and there have been many of them in just the past two decades: the bursting of the dot-com bubble, 9/11, and two bear markets in which stocks dropped more than 50%, to name just the big ones. And the blink moments happen on the upside, too. The temptation to invest in those dot-com stocks in the late ‘90s, or in speculative real estate in 2006, or in Bitcoin in 2017, was a siren-song many investors couldn’t resist, and they paid dearly for it.

Like most everything else in the world today, the commoditization of investment management is in full swing. The drive is on to break down financial planning and wealth management into its mechanical parts. Asset allocation recommendations are available at the push of a button on a web site. Stock trades can be executed with the swipe of a finger. Financial planners are available to chat in apps.

This commoditization is missing the big picture. While analytics, plans and platforms are certainly important tools in the wealth management process, they are just that – tools. It’s the relationship you have with your advisor that really counts in the blink moments; those are the critical times when you have to be able to trust their counsel even if – especially if – you don’t trust your own decision making in that moment.

It’s in those times, when emotions are at their peak, that investors face the greatest threat to their financial wellbeing. The first and most important role of an advisor is to be the trusted buffer between the client and their money when those moments arise, as they surely will.

For the better part of the 20thcentury, most investors followed a similar approach to constructing an investment portfolio. They used a stock broker to buy a handful of stocks they liked (or that the broker convinced them to like) and held them in the portfolio for the long-term.

Two things changed this dynamic in the 1970s. First, the long, deep economic slump in the United States during that decade introduced many investors to the reality of securityrisk– the risk you assume when you have a concentrated stock portfolio and your investment fate is tied to the fate of only a handful of companies. Many shareholders of U.S. auto stocks, airlines, and banks found this out the hard way during that decade.

This awakening of the investing public to the perils of security risk also coincided with the explosion of mutual funds in the late 1970s and early 1980s. Mutual funds enabled investors to diversify away security risk by having exposure to hundreds of different securities, all from a single investment. As a result, in the ensuing four decades, mutual funds became the preferred way for investors and their advisors to allocate investment assets. It’s rare today for long-term investors to concentrate new investment proceeds in just a handful of companies. 

However, we still see three scenarios where certain investors come to us with a significant portion of their net worth concentrated in one, or several, stocks:

Businesses owners who’ve sold their company for stock in the acquiring company.

Heirs who have inherited large positions of low-basis stock.

Retired executives who have amassed significant amounts of stock in the companies they worked for through bonuses and options.

The path to amassing these concentrated stock positions is varied, but the resistance to diversifying away the security risk inherent in such positions almost always falls into two categories. Either the investor is opposed to selling the positions and incurring capital gains taxes, or they have seen the stock outperform the broad market and are convinced the outperformance will continue. Many times it’s both.

We certainly sympathize with these concerns; it’s never fun to sell a stock that has performed well, or even adequately, and pay the resultant capital gains taxes. But it’s also not fun to have the misfortune of being trapped in a stock that suddenly experiences a dramatic downturn – sometimes temporary and sometimes permanent – due to circumstances in the company unrelated to the overall stock market. The news was rife with such examples in First Quarter 2019:

Boeing Corp: After a second crash of the aircraft manufacturer’s 737 Max airliner raised questions about the safety of the plane’s flight-management software, Boeing’s stock fell 18% over a three-week period in March.

Kraft-Heinz: After an earnings miss by the consumer products giant raised investor fears that massive cost-cutting at the company was having an adverse effect on future profitability, the stock plunged 27% on February 22. Kraft-Heinz stock is now down nearly 50% since November and down 65% from its November 2017 high.

Prada: The maker of handbags and other high-fashion accessories saw its shares drop 11% in a single trading session in March as consumer demand for the brand in China dropped dramatically.

All of these occurred while the broad stock market was surging. They are but recent examples, and we have seen many other, more heart-wrenching instances in the past twenty years of investors who were wiped out by being in the wrong stock at the wrong time; Wachovia, Delta, Enron, WorldCom, GM and Lehman all come to mind. Investors in those stocks would dearly love to turn back the clock and diversify their once-concentrated positions of now worthless stocks.

The bottom line is that diversifying and/or hedging concentrated stock positions – however painful or challenging it may be – is a way of hedging against future, unknowable corporate catastrophes. As risk managers, we view this philosophy as necessary in order to avoid the unthinkable down the road. 

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

How much Retirement Income is right for you

Source:  Morningstar, Inc.; Lipper; Bloomberg; Capital Directions. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.

Fourth Quarter 2018 Was So Much Fun

What did Fourth Quarter 2018 tell us about the future? Not much more than the rest of 2018 did. But in case you missed it, stocks around the globe experienced a significant decline during the quarter, a trend that began in October and accelerated rapidly in December. The downturn was widely attributed to the prospect of continued higher interest rates, ongoing tensions in the trade war between the U.S. and China, and earnings pressure on technology giants such as Facebook and Apple.

The December sell-off was steep and significant, with the Dow dropping more than 12% and the Russell 2000 small stock index dropping almost 14% in just nine trading sessions from December 12 - 24. Other than the one-day “Flash Crash” of 2010, it was the most significant bout of volatility for stocks since the 2008-09 financial crisis. The decline brought the Dow Jones Industrial Average within a fraction of a percent of a bear market (defined as a 20% decline from peak to trough).

While the percentage declines were significant, they have been nowhere near the declines seen in 2008-09. The breadth of the declines across so many asset classes, however, was historically significant. According to a Deutsche Bank / Bloomberg Finance report, some 93% of all global asset classes experienced a negative total return in 2018. That was the highest percentage of asset classes to experience a decline going all the way back to 1901.

Percentage of Global Assets With Negative Total Returns

When a downturn hits the stock market that is both deep and wide, the news media, predictably, goes into full crisis mode. Stories appear almost continually on our TVs and financial news web sites, chronicling the downturn in real time and warning about the possibility that the decline may yet get worse. In such times of turmoil, it becomes challenging for long-term investors to avoid the temptation to make short-term moves with their investments.

Have you ever bought that fancy health food magazine off the rack in January after you indulged too much over the holidays? Yes, I know most of us have (which I'll discuss why below).

It is precisely at these inflection points in the market that long-term investors must avoid that temptation. History has shown us, repeatedly, that making rash decisions with our investments during periods of extreme volatility is almost always the wrong thing to do, because it creates two critical decisions that must be correctly made: when to get out of the market, and when to get back in. Making a wrong move on either or both of these decisions can result in a tremendous loss of investment capital. As many of you have heard me say, sometimes it is not about being smarter than everyone else, but instead doing a lot less stupid things that allows you to have a successful investing experience.

WHO SHOULD WORRY

No matter how disciplined one is, it's not easy to watch such large market movements as we saw in December. The only people who might have a reason for concern when this happens are:

Retirees taking income from their portfolio

Investors with NO financial plan in place

For investors who are well-diversified, have a sound retirement income strategy and wealth management plan in place, perspective is the most important quality to maintain during times of market turmoil. In that regard, here are three points to keep in mind in the current market environment:

We were due for a bear market: Actually, by historical standards, we were overdue. On average, the stock market experiences a correction (a decline of 10%) about once a year, and a full-fledged bear market about every 3.5 years. Prior to the current downturn, the last 20% decline in the S&P 500 occurred in 2008-09. From that perspective, a bear market shouldn’t come as a surprise.

The thing about past bear markets, of course, is that we know how they turned out. We don’t fear the 1973-74 bear market, when the Dow dropped 45% and bottomed out at 577, because it’s ancient history; a once-scary story that we now know has a happy ending. Even the 2008-09 bear market doesn’t generate the same anxiety today, with the Dow about 20,000, as it did in real time, when the Dow bottomed out at 6,443.

In real time, though, we don’t know where the market bottom is, and that’s where the anxiety lies. Fear of the unknown often causes investors to make panicky, emotion-driven decisions in an effort to “protect” their assets by reducing or even eliminating their stock exposure usually after the market has already made a substantial move downward.

The thing about moving to the perceived safety of less volatile investments like bonds and cash during a downturn is that, once the dust clears and the market turns up again, it usually turns up in a big way. Much of the recovery happens before most investors realize it, and big gains that were there for the taking by those who are fully invested are missed by those sitting on the sidelines.

The recovery from the bottom of the 2008-09 bear market is a vivid example. Once the bottom was reached on March 9, 2009, stocks took off rapidly and unexpectedly. By June 30, 2009, the Dow had gained 29.47% from the bear-market low; by year-end 2009, it had gained a whopping 61.98%.

Even the events of the past few weeks have illustrated this tendency of stocks to bounce hard off their lows. After hitting a recent low of 21,792 following a 653-point plunge on Christmas Eve, the Dow, as of this writing, has recovered nearly 2,500 points and nearly 11%. Whether stocks revisit their lows again in the short term, go lower still or start rising and never look back – no one knows. What we do know is that, once the volatility settles down and the market is in calmer seas, stocks typically spring back in dramatic fashion.

In turbulent markets, focus on the process, not predictions: No one can control the direction of the stock market, so it makes sense to focus on the things we can control in down markets. For taxable investors, a stock downturn can offer an opportunity for portfolio rebalancing and tax-loss harvesting to help offset taxable income. Focusing on maximizing the efficiency of the wealth management process during turbulent times helps to reduce the anxiety of wondering when the market volatility will end.

Take a break from the news: A half-century ago, investors didn’t have the ability to follow the stock market moment-by-moment. They might hear a mid-day report on the radio, and then get a brief market recap on the nightly news at day’s end. Other than that – out of sight, out of mind.

What a contrast to the world we live in today. Our phones push market information to us constantly, with stock ticker apps, email alerts, and updates on our internet browsers every time we open Chrome, Explorer or Safari. Even if we wanted to, it would require a genuine effort to be unaware of the constant fluctuations of the market – especially when the market is in a downturn. Eyeballs equal money for content providers, and the more dramatic they make the content, the more likely we are to watch or click on it. These TV shows and web sites are populated with a legion of so-called experts pontificating on where the market is heading and what stocks to buy or sell to minimize the “damage” to your portfolio.

SEARCHING FOR EL DORADO

Are you still wondering why we buy that new health magazine each year or seem to try the latest workout craze that is "guaranteed" to be the answer? What if instead these media outlets told you to work out more, eat better, and get more rest? How many magazines would they sell beyond the first issue? You know the answer.

All of it is bunk. If these experts truly knew where to be ahead of time, they wouldn’t need to work for a living. Given that 80% of mutual-fund managers – among the best and brightest minds in the investment industry – routinely underperform the market over 10-year periods, why would we believe that the analyst-du-jour on CNBC has any better grasp of how to beat the market?

The herd mentality becomes strong during periods of extremes in the stock market, both on the upside and the downside. Just as it seemed the smart money was in dot-com stocks in 1999 and Florida real estate in 2006, the opposite mentality sets in during down markets. We hear water-cooler conversations among friends and family about how this downturn just “feels different” than others, or why someone has moved their entire 401(k) allocation to cash until things calm down.

During periods of market turbulence, it’s important to remember that individual investors, as a group, are notoriously out of synch with market reality. The guesses and opinions our friends and neighbors are offering about the market aren’t any different than those offered by the talking heads on TV. It’s all based on hunches and suppositions, and that’s no way to manage your investments. To the contrary, process, discipline and a healthy dose of emotional detachment are the best ways to ride out a downturn in the market.

As always, we appreciate our relationship with you and we are here to help.

Best,
Marc

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Source:  MSCI; Deutsche Bank; Bloomberg; Standard & Poors; Morningstar, Inc. Dimensional Fund Advisors LP. DFA 2018 Mutual Fund Landscape Report. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.M & A Consulting Group, LLC, doing business as CAM Investor Solutions is an SEC registered investment adviser. We provide financial planning and investment information that we believe to be useful and accurate. However, there cannot be any guarantees. There are many different interpretations of investment statistics and many different ideas about how to best use them. Nothing in this presentation should be interpreted to state or imply that past results are an indication of future performance. Tax planning and investment illustrations are provided for educational purposes and should not be considered tax advice or recommendations. Investors should seek additional advice from their financial advisor or tax professional.