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Alan McKnight, MBA, CFP®
April 12, 2017
Stocks rose solidly in the 1st quarter of 2017 as momentum from November’s presidential election kept the rally going. Led by the technology sector, which had done very little after the election, equities started the year with very strong gains. Despite backing off of all-time highs, the Dow rose 4.6% to close at 20,663, marking its sixth straight quarter of gains. The S&P 500 gained 5.5% for the quarter while the NASDAQ rose 9.8%. This past quarter ranks as the third best start to a year in the last ten years, behind both 2012 and 2013. This was quite a contrast to the market start in 2016!
While the quarter was strong overall, the month of March ended on a weak note. Since making an all-time high on March 1, the S&P 500 has failed to make new headway. It still ended the quarter only 1.4% below its highs. The Dow also showed some caution signs in March. At one point during the month, it closed down for eight straight days, but only lost 1.9% during that period of time. This was certainly no correction, generally defined as a drop of at least 10% in the market. Corrections, unlike crashes, are normal and are temporary price declines interrupting an uptrend in the markets.
After a rough 4th quarter of 2016, the U.S. Aggregate Bond Index rose 0.78% for the 1st quarter. This index is designed to measure the performance of publicly issued U.S. dollar denominated investment-grade debt. Most diversified portfolios typically include bonds of this type.
This quarter featured the Fed raising the federal funds rate by 25 basis points in March to 0.75%-1.00%. The Morningstar Core Bond Index, one of the broader measures of the fixed-income universe, rose 0.85% in the first quarter. Returns for the largest money funds are still below 1%. In some stable rated countries like Germany, the yield on Germany's 10-year bond almost doubled this past quarter, but that means it rose only 18 basis points to 0.39%.
The bull market officially turned 8 years old in the 1st quarter. March 9, 2009, marked the bottom of the market during the Great Recession. At 96 months old, this bull market is not the oldest in modern history (post-World War II). That title goes to the bull market that lasted from the fall of 1990 to the early spring of 2000, or 113 months, according to CFRA and S&P Global. That record bull market, which is also the best-performing with a 417% gain, lasted just more than a year longer than the current bull market's age.
The current bull market isn't even the runner-up in performance. The baby-boom bull market in the 1950s is the second-best performer, with the market having risen 267% during its seven years. Also, the current bull market is not the one in which stocks became most expensive, though it's getting close. The S&P 500 was trading at a multiple of 30 times earnings in 2000, and 26 times earnings when it was the same age as the current bull. Today, the S&P 500 has a price-to-earnings multiple of about 25.
Many are wondering if this bull market will continue. The stock market has continued to be strong, but a recent Wall Street Journal article noted that a correction now might not be so bad. They report that after the post-election rally, some analysts say a 10% retreat is overdue and would be healthy for the market. Market corrections occur once per year on average, according to the WSJ Market Data Group, using data going back to the late 1980s. However, the eight-year bull market has seen only four corrections while stock prices have tripled. That’s an anomaly. As for now, investors are better served by having a strategy that includes being watchful but NOT emotional.
The Dow Passes 21,000 in March
The Dow closed the quarter at 20,663, but on Wednesday, March 1st, it closed above 21,000 for the first time ever, marking one of its quickest runs to such a milestone. The index closed above 20,000 on January 25, marking a then-second-fastest push (42 days) to a 1,000-point milestone. The Dow’s latest milestone matched the fastest-ever such move at 24 days, equaling the same span of trading sessions between 10,000 and 11,000 in May 1999.
While Dow milestones create a great deal of attention, investors should note as the market rises, each 1,000-point advance becomes smaller on a percentage basis. The move from 20,000 to 21,000 marks a 5% rise, while the move from 19,000 to 20,000 was a 5.3% move. The move between 10,000 and 11,000 in 1999 marked a 10% rise.
While a rise in the Dow always sounds great, here are a couple of other key facts about the index on its climb to 21,000:
These bits of Dow trivia may be interesting, but for most investors, it is prudent to focus on personal financial goals and NOT the hype, regardless of what number the media chooses to focus on next.
For 2017, interest rates remain on investors’ watch list. An entire year passed between the first interest-rate increase in December 2015 and the second in December 2016. The Fed’s 0.25% rate hike in March 2017 was the first of the three that they suggested we could see this year. While the prospect of rising rates has many investors paying careful attention, Bill Irving, Manager of several Fidelity income funds including Fidelity’s Government Income Fund, reminds investors that the Fed does not control the entire yield curve. He shares that changes in the federal funds rate most directly affect the short end of the curve, or shorter maturity bonds. Investors understand that when the Fed raises rates, it pushes up yields on short-term bonds, but Irving reminds us that yields on 10-year bonds, for example, can be affected by a whole host of other factors, including risk sentiment, expectations for inflation and economic growth, and investors' demand for longer-maturity securities.
To simplify a complicated analysis, the long end of the yield curve doesn’t always move in sync with the short end, so the Fed’s rate increase may not cause rates to rise or prices to fall on longer-term bonds. For investors looking for income returns, bond yields are still historically on the lower side. Stephen McBride wrote in Forbes that even with inflation at its highest level since 2012, the Fed said monetary policy will remain accommodative “for some time.” As has been the case in the past, the Fed is willing to let inflation consolidate above its 2% target before embarking on a more aggressive tightening path. The consumer price index (CPI), the most widely used measure of inflation, averaged 2.67% for the first two months of the year. Even if inflation averages only 2% for all of 2017, the Fed’s target, low interest rates could be still the norm for investors and savers alike.
Following the March rate hike, USA Today reported the fact that the Fed has enough faith in the economy to boost rates is a good thing, according to James Paulsen, Chief Investment Strategist at Wells Capital Management. They remind investors that in a rising rate environment, the price, or the value of the bond falls. They also share that when the Fed hikes short-term rates, interest that banks pay out on savings accounts will also go up, but they advise not to expect a windfall. The Bond Rate Scoreboard they posted on March 14, 2017, shows that rates on 2- and 10-year Treasuries are still low. The top-yielding savings accounts available nationwide are now in the 1% to 1.25% range, according to Bankrate.com. They report that, even if the Fed boosts rates three times this year, or three-quarters of a percentage point, bank account yields will rise to 1.75% to 2%, according to estimates from Greg McBride, Chief Financial Analyst at Bankrate.com. "It helps savers," he says. But there's a caveat. The buying power of the still-low-yielding cash will be eaten up by inflation.
Interest rates are an area that we will continue to monitor this year, especially after March’s lackluster jobs report.
While the 1st quarter was a healthy one, it is always prudent to be watchful of upcoming factors that may affect markets such as geopolitical unrest, potential U.S. political gridlock, possible oil price fluctuations, and interest rate movements can all have significant impacts on the U.S. and world investment markets. As geopolitical events heat up and as we head into earnings season, we always advise using caution when making any portfolio changes. It is helpful to always discuss your personal situation with your advisor before making any major changes.
Moving ahead, Blackrock, the world’s largest asset manager, feels global growth expectations are on the rise, and they see room for more upside surprises. They also advise investors that inflation expectations have rebounded from lows in mid-2016, and actual inflation is slowly following. When it comes to yield, they advise that the search for yield is still on in the low-return environment and income-producing assets are in short supply. They like equities, but caution investors that U.S. equities do not look cheap, and gains since the presidential election have been powered mostly by multiple expansion or what we would consider being willing to buy stocks with a higher multiplier.
Russell Investments tells investors that they maintain a call for caution as inflated expectations for global growth and U.S. fiscal policy drive markets higher, despite looming global economic headwinds. In the medium-term, they are not bearish, and they feel that the U.S. economy shows relatively low recession risk.
Fidelity Investments is warning investors to keep a watchful eye on inflation. They advise that U.S. inflation has slowed structurally since the early 1980s, due in part to central-bank policy measures aimed at managing long-term inflation expectations. While they feel it’s possible that inflation will remain subdued over the long term, this outlook appears largely priced into asset markets. However, there are dynamics at play that could contribute to ending the longstanding disinflationary trend in the U.S. They warn that there are a lot of uncertainties behind their outlook but feel that the U.S. stock market seems poised to resume its rally, while keeping an eye on a valuation headwind that could partially offset an earnings tailwind. They caution that Treasury yields could continue to hover around fair value with an equal emphasis on real rates and inflation expectations as well as if the dollar has peaked, international stocks could benefit.
What Should an Investor Do Now?
Investors are typically concerned about their portfolios and returns. Trying to generate high returns while achieving diversification can be very difficult. The definition of conservative investing includes using a strategy that seeks to preserve an investment portfolio's value by including investments in lower risk securities such as fixed-income and money market securities. With today’s low interest rates this means that moderate and conservative investors could have returns that are not those of full equity exposure. A well-diversified and balanced investor will have returns that are reflective of benchmarks that hopefully include some safer returns than full equity exposure. In this rising market, that means a well-diversified and balanced portfolio will generate lower returns than a full equity portfolio. While higher risk has been rewarded for some in the current market, investors who are fully invested in equities are usually aggressive investors and that means they may endure extensive volatility and significant losses. Investing is personal, and your ability to take risks depends on a variety of factors.
Your focus should be on trying to meet your personal goals and not based on returns generated by an investor who is willing and able to take more risk. With equity markets having advanced, this is a good time to revisit your risk tolerances and time horizons. Many analysts are predicting a volatile ride in equities for the rest of 2017. However, safety comes with a price. For many investors today’s traditional fixed rates will not help them achieve their desired goals. Most investors attempt to build a plan that includes risk awareness. Many times this can lead to safer but lower returns. Traditionally, bonds have been used as a nice hedge against market risk, but with interest rates projected to continue to rise, investors need to be cautious.
It is always wise to create realistic time horizons and return expectations for your own personal situation and to adjust your investments accordingly. We try to understand your personal commitments so we can categorize your investments into near-term, short-term and longer-term.
Investors need to be prepared. Market volatility should cause you to be concerned, but panic is NOT a plan. Market downturns do happen and so do recoveries. This is the ideal time to ensure that you fully understand your time horizons, goals and risk tolerances. Looking at your entire picture can be a helpful exercise in determining your strategy. We always welcome the opportunity to discuss any updates to your thoughts or situation.
I have had several discussions in the past few weeks with many clients who are fearful of the most recent geopolitical events. Uncertainty over the U.S. government's strategy in Syria and how President Donald Trump plans to neutralize North Korea's nuclear threat are rattling investors. A few clients have asked me about sitting on the sidelines for a while. This is rarely, if ever, a good idea. As I continually remind clients, there is probably never going to be a time that you are going to feel warm and fuzzy about world events. Take a look at the table at the end of this letter entitled, “Major World Event Since 1997.” I simply went back in time over approximately the last 20 years. With the help of MarketWatch.com and my memory, I was able to write down one or two major events that occurred each of those years (1997 – 2017). The reality though is that there were probably dozens of things that happened those years that could have easily scared investors out of the markets temporally or even permanently. The common thread that is woven into these events is that we, the markets, and the economy all survived! I agree with Chris Kacher, managing director of MoKa Investors that, “Over the long term, the stock market always rises because intelligence, creativity, and innovation always trump fear.”
I have always called market timing a “fool’s errand” as it is rarely a profitable endeavor. While going to cash may make you feel better temporarily, you will simply go poor slowly over time as you lose purchasing power to inflation, even when inflation is at low levels.
Equity markets will continue to move up and down. Even if your time horizons are long, you could see some short term downward movements in your portfolios. Rather than focusing in on the turbulence, you might want to make sure your investing plan is centered on your personal goals and timelines. Peaks and valleys have always been a part of financial markets and it is highly likely that trend will continue.
Our advice is not one-size-fits-all. We will always consider your feelings about risk and the markets and review your unique financial situation when making recommendations.
A good financial advisor can help make your journey easier. Our goal is to understand our clients’ needs and then try to create a plan to address those needs. We continually monitor client portfolios. While we cannot control financial markets or interest rates, we keep a watchful eye on them. No one can predict the future with complete accuracy, so we keep the lines of communication open with our clients. Our primary objective is to take the emotions out of investing for our clients. We can discuss your specific situation at your next review meeting, or you can call to schedule an appointment. As always, we appreciate the opportunity to assist you in addressing your financial matters.
If it has been more than a year since your last financial review, please give Jan Berkholtz a call at our office to schedule an appointment so we can make sure everything is in order. If you feel the need to discuss your situation before our next scheduled review, please call our office at (770) 951-9001 or e-mail me at firstname.lastname@example.org.
Alan McKnight, MBA, CFP® is Vice President of Kays Financial Advisory Corporation. He has over 20 years of experience working with retirees and pre-retirees. He is an Adjunct Faculty Member and Professor of Finance and is an Ed Slott Master Elite IRA Advisor. Currently he is a doctoral candidate at the University of Florida, and his area of research interests include: Investments, Securities Analysis, Behavioral Finance, Asset Allocation and Risk Management. He can be reached at (770) 951-9001 or at email@example.com.
This report and Mr. McKnight’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any company and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned herein.
Sources: Forbes, Fortune, Wall Street Journal, Oppenheimer Funds, Barron’s; USAToday; The Washington Post; BlackRock Market Watch Outlook; Russell Investments Global Market Update; Fidelity Investments, APFA, Inc., Forefield.com, MarketWatch.com.
Major World Events Since 1997
1997 Asian Currency Crisis/Hong Kong and Global Stock Market Rout
1998 U.S. Intervenes to Support the Yen/African Embassies Bombed
1999 NATO Bombs Serbia/Y2K Millennium Scare/Columbine Shooting
2000 Bush Vs. Gore Election Recount/The Tech Crash/Terror Attack on USS Cole
2001 9/11 Terror Attacks/Enron Scandal
2002 War on Terror/Accounting Scandals/Mutual Fund Trading Scandals
2003 Invasion of Iraq
2004 War on Terror/Multiple Terrorist Attacks Worldwide
2005 Record High Oil Prices/Hurricane Katrina/North Korea Produces Nuclear Weapons
2006 Housing Decline Begins/Nuclear Weapons North Korea and Iran
2007 Pakistani Prime Minister Bhutto is Assassinated/Credit and Subprime Mortgage Debacle
2008 Credit Crisis/Financial Institution Failure (Bear Stearns, Lehman Brothers)
2009 War on Terror/Climate Debate/Healthcare Reform/North Korea Conducts 2nd Nuclear Test
2010 Horizon Gulf Oil spill (BP)/Flash Crash, European Union Crisis
2011 Debt Ceiling Crisis/United States Credit Rating Downgraded.
2012 Benghazi Terrorist Attacks/U.S. Fiscal Cliff/European Debt Crisis/More Terrorist Attacks Across Europe
2013 Boston Bombing/Government Shutdown/NSA Leaks
2014 Ebola Virus/ISIS is Born/Police Protests/Plummeting Oil Prices
2015 ISIS Attacks in Paris, France. Russia Air Strikes in Syria/Refugee Crisis/ China Slowdown/Fed Rate Hike
2016 The United Kingdom (BREXIT).
2017 North Korea Fires Ballistic Missile Across the Sea of Japan/U.S. Launches Air Strike on Syrian Air Base