Why this Bear Market Feels so Different, and What Not to Do Now

It’s official – the almost 11 year bull market is over thanks to a couple of “black swans”: COVID-19 and the oil price war.

Quick terminology recap here:

  • Pull-back – a falling of a price from its recent high, typically 5%
  • Correction – typically 10% from recent high
  • Bear Market – 20%+ from recent high

Within a few weeks, we zipped past just a pull-back and correction and are officially in a bear market. Further, a recession is imminent with businesses about to take a hit from “social distancing” and broken supply chains. The US government is trying to get its arms around this threat and is working to eventually restore life back to normal. In the meantime, uncertainty continues. The market hates uncertainty and investors’ portfolios reflect that.

We’ve had pull-backs, corrections, and bear markets before. What’s different this time is the personal impact or the “human effect”. I think all of us have personally felt the coronavirus impact us in the last couple of days with upcoming plans being altered. Many are coping with tough travel decisions with Spring Break around the corner. Handshakes have turned into elbow bumps. Many employees are working from home. And our cherished past time of watching sports gets disrupted with major sports suspending their play. Heck, even Tom Hanks and his wife have tested positive for COVID-19.

Yes, this is certainly different from the Great Recession of 2008 as that didn’t impact personally like this threat has. And because of it, the level of emotion is stronger. And the emotion of fear is dominating right now. And with the help of the media, the fear is building upon itself and, for some, creating panic.

This downdraft has happened so fast – it was exactly one month ago that the stock market was hitting its all-time high – that even if you wanted to, it was almost impossible to react. Stock benchmarks are down over 25% as of this writing. This volatility for most is stressful, unnerving and can be tough to stomach. Fortunately, a balanced portfolio that holds multiple asset classes – not just equities, but fixed income and alternatives – has helped cushion the blow, but not by much given that most investment styles are down.

Emoji Graph

People struggle to separate their emotions from their investment decisions. See the slide above which shows how emotions relate to the different stages of the market. These emotions cause these investors to sell and buy at the worst times as this “recency bias” influences undisciplined investors to chase performance through buying high and selling low.

Now see the slide below which shows what happens when an emotional investor who went to the sidelines and missed the best ten days. The average annual return dropped from 6% to 2.4%. If that investor missed the 30 best days, their return goes negative.

Impact of Market Timing

The moral of the story is you don’t want to try to time the market. You should stay the course and stick with your long-term asset allocation target mix. We have had multiple discussions with our clients about risk. Risk tolerance, risk capacity, and risk perception. And from those discussions, we have identified appropriate long-term asset allocation target mixes. This crazy environment is a test of character to stay with that disciplined strategy and not give in to fear. It sounds hard to do, particularly, in scary times like now, but disciplined investing has ALWAYS paid off. The market inevitably always bounces off its lows to eventual new highs.

We aren’t calling this the bottom, by no means. We don’t know exactly what tomorrow brings. No one has a crystal ball. The market could trade lower, but if you have faith in our country pulling through this pandemic like it has in the past and understand this threat will be beaten, then remain disciplined and fully invested in your long-term asset allocation. We understand that everyone is wired differently and based on your current perception of the risk today, that may be hard to do. If so, please contact us so we can discuss further.

 

https://dwmgmt.com/

Coronavirus & the Dow Down 1000+ Points: Time to Panic?

The new coronavirus, dubbed COVID-19, has led to 80,000 infections and over 2600 deaths since originating in Wuhan, China in December 2019. This outbreak which the World Health Organization (“WHO”) has said is a “public health emergency of international concern” is a true human tragedy. Pretty scary at first glance, but taken in context it’s not so different from the normal flu. According to Centers of Disease Control, this season through February 7, more than 19 million people just in the US had caught the flu of which 10,000 died from it.

While the flu is caused by any of several different types and strains of influenza viruses, COVID-19 is caused by one virus, the novel 2019 coronavirus, now called severe acute respiratory syndrome coronavirus 2, or SARS-CoV-2.  When looking at the symptoms of COVID-19, we find that they are similar to that of the influenza (flu) virus, i.e. cough, runny nose, sneezing, sore throat, fever, headache, etc. Symptoms for both COVID-19 and the flu can be mild or severe and can result in pneumonia which can lead to death. According to WHO, the infection has been fatal in 2-4% of cases within Wuhan, but in less than 1% elsewhere. Rates go up for the elderly and those without sophisticated health care providers. Again, pretty similar to the normal flu.

Both COVID-19 and the flu can be spread from person to person through droplets in the air from an infected person sneezing, coughing, or just talking. Neither virus is treatable with antibiotics. Good news is that there has been promising work in the drug and vaccine space against COVID-19 but those need to be tested. Prevention methods for both include frequent, thorough hand washing, staying home when sick and limiting contact with those infected.

It’s still unclear as to how this situation will unfold and how much spreading of COVID-19 will take place. Fortunately, the immediate health risk for the general American public is low at this time. Further, it appears that China is getting the disease under control as the pace of infections (as represented by the “daily tally of new cases”) peaked a few weeks ago and has since steadily declined. However, reports over the weekend showed that the coronavirus is not only just appearing in other countries but unfortunately accelerating in some like Iran, South Korea, and Italy. The Italy news has many worried that Europe could be in the first innings of the ballgame China has been stuck in.

We’ve talked before how the stock market doesn’t like uncertainty and a virus like this only compounds that. We know in China that business has been severely affected. Not only are people avoiding going out to the movies and having fun outside, they’ve been told to stay home to stop further contagion. Most factories have basically been shut down since the Lunar New Year. These Chinese factories help produce many goods needed by world-wide manufacturers. If XYZ Company in Canada can’t get that one particular China-made good that goes into its finished project, it’s stuck in limbo until things clear up. Thus, we basically have a global supply-side shock in the making. Not good for the global economy! And don’t forget that China now accounts for 15% of the whole world GDP. Talk about ripple effect!

The odd thing that happened is that when COVID-19 gained notoriety in January, the US stock market sold off only to quickly recover and just recently was trading at record highs. The market shrugged off the bad news, putting it into the “one-time” event category or figuring that the global central banks would turn more dovish on rates and thus come to the rescue.

But the weekend news about Iran, South Korea, and Italy as well as the warning that an extended Chinese shutdown could cost the world up to $1 trillion in lost output, brought the fear back. Which led to the DOW’s worst trading day in two years, down over 1000 points yesterday!

So is it time to panic? Of course not.

COVID-19 is a terrible disease outbreak. Unfortunately, it’s not the first and it won’t be the last. We’ve seen this happen before; just think of the following: Ebola, Zika, Swine Flu, SARS. Let’s take a look at the market reaction to some of these:

Market reacts during virus outbreaks

The stock market sold off in all of these cases indeed. But more importantly is to see how the market recovered.

market heals after disease outbreak

As you can see, in most cases, the market typically recovers within six months.

We come back to our old saying of: control what you can control and don’t get emotional from the things you cannot.

Moreover, don’t let short-term market events alter your long-term planning. Unfortunately, humans are not wired for disciplined investing and usually trade poorly based on fear. So avoid that mistake by staying invested and staying disciplined and focusing on things that can be controlled:

  • Create an investment plan to fit your needs and risk tolerance
  • Identify an appropriate asset allocation target mix
  • Structure a well-balanced, diversified portfolio
  • Reduce expenses through low turnover and via passive investments where available
  • Minimize taxes by using asset location, tax loss harvesting, etc.
  • Rebalance on a regular basis, taking advantage of market over-reactions by buying at low points of the market cycle and selling at high points
  • Stay Invested

If you’d like to further discuss how disease outbreaks affect your portfolio and/or long-term financial planning, don’t hesitate to contact us.

 

https://dwmgmt.com/

DWM’s 4Q19 Market Commentary & A Look Into 2020

Happy 2020! No doubt you have heard the term “20/20 vision” over the last several weeks as we enter this new decade and all of the imagery that comes with it. As you probably already know, 20/20 vision is synonymous with perfect vision. As financial Sherpas, we are always striving to provide our clients with that – to observe, to envision, to help foresee, to project, and to be on the lookout! We can’t guarantee that our outlook will be spot on, but we certainly can help our clients plan and make projections for what’s next on the horizon.

But before telescoping ahead, let’s look back on fourth quarter 2019 (“4Q19”) and calendar year 2019 and the bedazzling year it was! We’ve put the magnifying glass on this investment landscape panorama so you can visualize the details!

Equities: No, it wasn’t a hallucination… Equities, as evidenced by the MSCI AC World Index, rallied to close the year, up 9.0% for 4Q19 and an eye-popping 26.3% for the year! Domestic large cap stocks*, particularly the growth-oriented FAANG group**, kept outperforming, up 9.1% and 31.5%, 4q19 and YTD, respectively. International equities* also participated in the 4Q19 rally, +8.9% for the quarter, to finish the year +21.5%. Unlike the growth and momentum-driven environment of late, we and many other experts expect valuations to actually matter in 2020.

Fixed Income: Don’t get bleary-eyed just yet, as the positive readings keep coming! In a blink of the eye, the Fed went from a hawkish stance to a dovish one which amounts to massive liquidity support and lower rates, which in turn pushes bond prices up as evidenced by the Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index turning in a solid quarter, up 0.2% and 0.5%, and an eye-catching year-to-date (“YTD”) return of 8.7% and 6.8% respectively!  The Fed appears to be on hold for the foreseeable future, thus barring a setback on trade, we expect Treasury yields to move higher as recession fears fade.

Alternatives: Sometimes this asset class goes unnoticed or invisible, but not in 2019 as alts produced some very good returns. In fact, the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, showed a 2.2% gain on the quarter and finished up 8.1% for the year! Standouts include infrastructure*** (+2.9% 4Q19 & +27.8% YTD) and gold**** (+2.8% on 4Q19 & +18.0% YTD). Such spectacles!

Recall that in 2018 almost every asset class and investment style went down; 2019 was pretty rare in the sense that it was just the total opposite of that – virtually everything went up, i.e. no blind spots! In fact, the balanced investor – those with sizable allocations to equities, fixed income, and alternatives – should be seeing double-digit returns in the teens! Pretty amazing! The key is not to be short-sighted and getting caught up in recency bias. One needs to be realistic when planning for the future. If you are thinking that the environment is as pretty as the light prism above, you have blinders on. Alas, here is some near term darkness:

Investor sentiment is really high now with all the recent good news. That typically is a leading indicator of less-than-stellar times. And because of this high investor sentiment and recent stock market rally, valuations in certain areas, particularly the S&P500, are getting uncomfortably high. The market seems almost priced to perfection. So far the market has shrugged off scary news like the recent US killing of Iran’s most famous military commander. But it’s only speculation that that can continue. Further, manufacturing and business investment is still struggling, which will most likely continue until we get a more comprehensive trade deal, more than the vague preliminary one being discussed now. The good news is that it appears that US and China are both working on a resolution, but don’t be dazed and confused if talks fall apart. And, of course, we have an upcoming Presidential election which brings more uncertainty into the mix.

In conclusion, it’s a beautiful scene right now with most investors’ portfolio values near all-time highs. But like rays of light, the direction of the markets and portfolios don’t forever stay the same. We are here to help now and also when the light ray inevitably bends.

DWM enjoyed watching out and doing all it could for its clients in the last decade. And as we now start into this new decade, we continue to be on the lookout over our clients, their portfolios, and their wealth management needs. Serving our clients make us smile. On the flash of light, we say “cheese”!

Cheeky Smiles

As always, don’t hesitate to contact us with any questions or comments.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

*represented by the S&P500 Index

** FAANG = Facebook, Amazon, Apple, Netflix and Google

***represented by the Frontier MFG Core Infrastructure Fund

****represented by the iShares Gold Trust

 https://dwmgmt.com/

DWM 3Q19 Market Commentary

“Fancy a cuppa’?” “Anyone for tea?” Even though our beloved Chicago Bears were “bloody” unsuccessful in their visit to London this past weekend, I’m “chuffed to bits” to put a little “cheeky” British spin on this quarter’s market commentary… Let’s “smash it”!

After a volatile three months, the third quarter of 2019 is officially in the history books. The S&P500 finished only 1.6% below its all-time high, bonds rallied as yields lowered, and alternatives such as commodities and real estate rallied. It’s been a rather “blimey” year for investor returns so far, but there’s a lot of uncertainty out there about if these “mint” times can last. Let’s look at how the asset classes fared first before turning to what’s next.

Equities: Equities were about unchanged for the quarter, as evidenced by the MSCI AC World Index -0.2% reading for the quarter.  Domestic large cap stocks represented by the S&P500 did the best relatively, up 1.7%, but underperformed in the final weeks of the quarter. Recent trends show that traders are gravitating toward stocks with cheaper valuations instead of pricey, growth ones. International equities* underperformed for the quarter, down -1.8% but had a strong showing in September. Even with this so-so quarter, stocks, in general, are up over 15%** Year-to-Date (“YTD”)! Yes, “mate”, this bull market – the longest on record – continues, but at times looking “quite knackered”.

Fixed Income: The Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index ascended even higher, up 0.7% and 2.3%, respectively for the quarter and now up 6.3 & 8.5%, respectively YTD. “Brilliant!” Yields continue to fall which pushes bond prices up. But how far can they fall? The 10-year US Treasury finished the quarter at 1.68%, a full percentage point below where it started the year. For yield seekers, at least it’s still positive here in the States as the amount of negatively yielding debt around the world swells. Sixteen global central banks lowered rates during the quarter including the US Fed, all of them hoping to prop up their economies. As long as they’re successful, all is good. But what if our slowing US economy actually stalls? We could be “bloody snookered”…

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, showed a +0.3% gain and now up 6.1% YTD. Lots of winners in this space. “Lovely!” For example, there is a lot of money flowing into gold***, +4.4% on 3q19 & +14.7% YTD, as it is seen as a safe haven. And real estate, +6.3% 3Q19 and +23.5% YTD, has rallied from investors looking for yields that are more than the bonds like those mentioned above.

Frankly, it’s been a pretty great year for the balanced investor who’s now looking at YTD returns that around double-digits. But it’s not all “hunky-dory”. The main worries are the following:

  • The US-China trade war continues affecting the global economy. Sure, since the US exports less than every other major country, this shouldn’t affect us as much. But given the uncertainty, many companies are choosing to hold off on capital expenditure until we get clarity on this issue. Reports earlier this week that US manufacturing momentum has seriously slowed down led to one of the worst fourth quarter starts for the stock market in years. Politics will continue to make it volatile.
  • The Fed’s path of monetary easing. It’s gotten “mad” – it seems every time there is bad news, it’s good news for the stock market because traders are betting on the central banks around the world to support the markets. Seems “dodgy”, right?!? So the Fed must play this balancing act, always wanting to keep the economy humming along. Quite frankly, there really is no economic reason for a rate cut right now if it weren’t for the trade conflict. Figure we’ll have at least one more cut, possibly two, in 4Q19 and hopefully that’s it. Otherwise, if they keep lowering, it means we have fallen into a recession.

It’s in a lot of peoples’ interest to get a trade deal done. If it does, markets will celebrate it. The longer a deal plays out, the more volatility we’ll see and the higher the risk of recession becomes. The US economy is not “going down the loo”, but it won’t continue to go bonkers with everything mentioned above as well as the Tax Reform stimulus fading away in the rear-view mirror as quickly as a Guinness at the Ye Olde Cheshire.

This all isn’t “rubbish”. Actually, there is a lot of turmoil out there. So don’t be a “sorry bloke”. In challenging times like this, you want to make sure you’re working with an experienced wealth manager like DWM to guide you through.

Don’t hesitate to contact us with any “lovely” questions or “brilliant” comments, and Go Bears!

“Cheerio!”

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the MSCI AC World Index Ex-USA

** represented by the MSCI AC World Index

***represented by the iShares Gold Trust

****represented by the iShares Global REIT ETF

DWM 2Q19 Market Commentary

Carnival Pic

Summer is finally upon us! Weather is steamy, kids are out of school, and it’s the midst of carnival season. Merriam Webster has several definitions of carnival including:

  • An instance of merrymaking, feasting, and masquerading
  • An instance of riotous excess
  • An organized program of entertainment or exhibition

Sounds a little bit like the markets we’ve seen in 2019 so far: it’s certainly been an entertaining program with all asset classes parading higher. But does this Fun House continue or is it all just a House of Mirrors….

Equities: You win a small prize! Equities continue to be the most festive part of the fairground, with many stock markets up over 2-4% on the quarter and now up around 12-18% on the year! Domestic and large cap stocks continue to outperform value and smaller cap stocks, which is typical of a late-stage bull market, this one being over a decade-long!

Fixed Income: You can trade in that small prize for a medium prize!  Like a Ferris Wheel where one side goes up, the other side comes down; yields and bond prices operate the same way. With the 10-yr Treasury now down to around 2.06% at the time of this writing compared to 3.2% last November, it’s no surprise to see strong returns in bond land. In fact, the Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index popped another 3.1% and 3.3%, respectively for the quarter and 5.6 & 6.1%, respectively year-to-date (“YTD”).

Alternatives:  You can trade in that medium prize for the largest prize! The merrymaking continues as most alternatives we follow had good showings in 2Q19, evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, up 1.3% and now up 5.7% YTD.

It almost feels like you could go over to the Duck Pond and pick up a winner every time. There are indeed a lot of positives out there:

  • US stocks near record highs
  • A stock-market friendly Fed
  • Historically low unemployment with inflation that appears totally under control
  • Americans’ income and spending rising, leading to relatively strong consumer confidence

But this carnival has some roller coasters in the making given some riotous issues including:

  • US-China trade tensions most likely not ending with a solid deal anytime soon, which will fuel anxiety
  • A weakening European economy due to tariffs and other issues, which could bleed over to all markets
  • Slowing US economic growth here as the Tax Reform stimulus wears off
  • A relatively expensive US stock market, evidenced by the S&P500’s forward PE ratio now at 16.7 times versus its 25-year average of 16.2

It definitely wouldn’t be fun if the yummy funnel cake turns into spoiled fried dough…Yuck! We don’t know exactly when or what will happen, but we do know that at some point this bull market will indeed end. You cannot time the market so forget about getting out of the Cliff Hanger before the time comes. That said, you want to stay invested and continue to control what you can control. Don’t wind up being on the bottom end of a Whack-A-Mole game; make sure your portfolio is prepared for the next downturn, which includes making sure your risk level within is appropriate for your risk tolerance.

So don’t wind up being a carny clown. If you want to continue hearing “winner-winner-chicken-dinner!”, work with a proven wealth manager and you’ll be the one controlling the Zipper!

 

Zipper

DWM 1Q19 Market “MADNESS” Commentary

In basketball, March Madness is a big deal. For those of you who aren’t familiar with the term, March Madness refers to the time of the annual NCAA college basketball tournament, generally throughout the month of March. In the market, it may appear that “Madness” is never confined to any one month. If you really want to talk about Madness, just think about the last 6 months: The S&P500 was at an all-time high late September, only to throw up an “airball” and bottom out almost 20% lower three months later on worries that the Fed was raising rates too fast, only to “rebound” to have its best first quarter since 1998 as the Fed shifted its tone to a more dovish nature. Is it the NCAA or the markets in a “Big Dance”?!?

Yes, the investing environment now is so much different than our last commentary. Then, it certainly felt like a flagrant foul after a tenacious 4q18 sell-off that had gone too far. We advised our readers then to essentially do nothing and stay the course. And once again, rewards come to those that stay disciplined. With the market back within striking distance of its peak, it almost feels like its “cutting down the net” time. (“Cutting down the net” refers to the tradition of the winning basketball team cutting down the basketball net and giving pieces to team members and coaches.) But of course, the game of investing is not just four quarters like basketball. Investing can be a lifetime. So if you’re thinking about your portfolio like you would a basketball team, let’s hope its more like the Chicago Bulls of the 90s and not the 2010s! (Where’d you go, Michael Jordan?!?)

Like the Sweet 16 of the NCAA tourney, your portfolio holdings are probably like some of the best out there. But there will always be some winners and losers. Let’s take a look at how the major asset classes fared to start 2019:

Equities: The S&P500 soared to a 13.7% return. Small caps* did even better, up 14.6%. Even with a challenging Eurozone environment, international stocks** climbed over 10%. In basketball terms, let’s just say that this was as exciting as a SLAM DUNK for investors! Of course, with a bounce-back like this, valuations are not as appealing as they were just three months ago. For example, the S&P500 now trades at a 16.4x forward PE vs the 16.2x 25-year average.

Fixed Income: With the Fed taking a more dovish stance, meaning less inclined to raise rates, yields dropped and thus prices rose. The total return (i.e. price change plus yield) for most securities in fixed income land were quite positive. In fact, the Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index jumped 2.9% and 2.2%, respectively. Further, inflation remained under control and we don’t expect it to be a pain-point any time soon. But TIME OUT!: Within the last several weeks we have seen conditions where the front end of the yield curve is actually higher than the back end of the yield curve. This is commonly referred to as an “inverted yield curve” and has in the past signaled falling growth expectations and often precedes recessions. To see what an inverted yield curve means to you, please see our recent blog.

Alternatives: Most alternatives we follow had good showings in 1Q19 as evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, up 3.9%. Two big winners in the space were Master Limited Partnerships***, up 17.2%, and Real Estate****, up 15.2%. The pivot by the Fed in terms of their attitude toward rates really benefited the real estate space as new home buyers are now seeing mortgage rates almost a point lower than just several months ago. Unfortunately, not all alts did as well. Gold barely budged. And managed futures†, down 3.1%, were tripped up by the last six-month whipsaw.

So if you think of your asset classes as players on a basketball squad, one could say that pretty much every one had a good game, but the star of the show was definitely “LeStock”. Moreover, there was no buzzer beater necessary this quarter, as your team flat out won. In fact, most balanced investors after just one quarter are up high single-digits! A definite nice start to the year. You have now advanced to the next round, but where does your team go from here?

The game we saw in the first quarter cannot continue. With the Tax Reform stimulus starting to wear off, economic growth has to decelerate. In fact, companies in the S&P500 are expected to report a 4% decline in 1Q19 vs 1Q18; their first decline since 2016! World trade volume has really slowed down, so there’s a tremendous focus on a US-China trade agreement happening – if not, watch out! The good news is that the Fed seems to be taking a very market-friendly position, and unemployment and wage growth are under control.

As always, there are risks out there. But with the bull market on the brink of entering its 11th year of economic expansion, the end-of-the-game buzzer need not be close as long as you have a good coach at the helm. Just like within NCAA basketball, to succeed, you need a good coach on the sidelines – someone like Tom Izzo of the Michigan State Spartans who always seems to get his players to work together and play their best. The same way a wealth manager like DWM can help you put the portfolio pieces and a financial plan together for you in an effort to thrive and succeed.

So don’t wind up with a busted bracket. If you want a lay-up, work with a proven wealth manager and you’ll be cutting down your own nets soon enough. Now that’s a “swish”!

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the Russell 2000

**represented by the MSCI AC World Index Ex-USA

***represented by the Alerian MLP ETF

****represented by the iShares Global REIT ETF

†represented by the Credit Suisse Managed Futures Strategy Fund

Ask DWM: Should I Consider Investing in Marijuana?

In 1996, California became the first state to legalize the use of medical marijuana. This began, for many, the first opportunity to legally invest in this industry. In 2012, both Colorado and Washington State legalized the use of recreational marijuana. Both events were monumental for the development of marijuana investments but, arguably, the most momentous day in marijuana investments occurred on October 17th, 2018 with the legalization of recreational marijuana in Canada. In June of 2018, Canada voted “yes” to legalization and became the first major country to do so. Interest in these investments have soared ever since.

Cannabidiol (“CBD”) is one of the major attractions in this story. CBD is a cannabis compound used primarily for medical purposes. CBD has been proven to provide benefits for pain management, sleep aid, and stress. The primary difference between marijuana and CBD is its lack of hallucinogenic properties. CBD does not contain tetrahydrocannabinol (“THC”), the main hallucinogenic property found in marijuana. CBD is currently legal in all 50 states. As of February 2019, marijuana has been legalized in over 30 US states for medical purposes and ten, including Washington D.C., have approved it for recreational use.

Spending in the legal marijuana industry is expected to surge from $8.5 billion in 2017 to over $23 billion in 2022. As a side note and for comparison purposes, illegal sales of pot represented 87% of all North American sales and over $46 billion in 2016 according to Arcview Market Research. Hard to not get excited about those growth figures! Further, in a sign of credibility to the industry, major investments from some of the world’s largest beverage makers including Coca-Cola and Corona brewer Constellation Brands have created even more hype and have sent some pot stocks soaring. It’s not just Wall Street taking notice, but ordinary people are wondering if they should get in on the craze.

But just like Bitcoin & other cryptocurrencies, this upstart legal cannabis industry has many red flags and may lead to some scary results.

First off, “FOMO” or the Fear Of Missing Out is no reason to plow good money into a speculative area. It is prudent to do some serious research before dipping into the waters of an industry that faces many legal, regulatory and other hurdles. Further, beware of fraudsters on the internet claiming “this pot stock is the next big thing!” Investing in cannabis is like the wild, wild west and similar to the dot.com mania of the 90s with tons of extreme volatility and broken promises.

More specifically, there are a variety of risks associated with investing in this area. Marijuana is still not legal at the Federal level, which makes banking for marijuana companies within the US difficult and future issues uncertain. Second, most marijuana companies are considered “start-ups” where company revenues are low or nil, and they may be running at a loss. In addition to this, overall investments in marijuana continue to remain small, albeit growing, in comparison to developed industries. For example, the ETFMG Alternative Harvest ETF (symbol: MJ), one of the largest marijuana funds available, holds just $1 billion in capital. Lastly, with only a handful of well-known “reputable” companies in this area, don’t get burned by loading up in just one or two names and thus becoming subjected to company-specific risk.

If you are still interested in investing in marijuana, there are a few considerations to keep in mind. As a general rule, you should not allocate more than a couple percent of your total investment portfolio to one company name. Further, prudent portfolio management suggests to limit your overall exposure to a speculative area like this to no more than 5% of your total investable assets. Avoid concentrated company-specific risk and diversify. A diversified mutual fund or ETF like the ETFMG Alternative Harvest ETF (symbol: MJ) mentioned above is a great choice for those that aren’t good at research but “have to get in”…

At the end of the day, investments in marijuana should be considered widely speculative and highly susceptible to losses. Volatility in both specific companies and funds have been extremely high since their inception. Investments in these areas should be considered more like taking your money to Las Vegas. It’s a gamble and you could potentially lose your entire investment.

At DWM we consider ourselves to be financial advocates for our clients and we love being a part of all of our client’s financial decisions. Questions such as investments in marijuana have been a reoccurring theme as of late, eerily similar to those in 2017 about Bitcoin and we know what happened there….In other words, if you are still interested in this area, PROCEED WITH CAUTION!!!

At this time, DWM is not investing in marijuana for managed accounts due to the many issues mentioned above. For clients still interested in reviewing marijuana investments via a self-directed/unmanaged account, we welcome your calls.

DWM 4Q18 & YEAR-END MARKET COMMENTARY

Fantasy Football and portfolio management may be more similar than one would think. Over the past weekend, I drafted a playoff fantasy football team which I’m hoping will amass more points than the other five “owners” in my league. Fantasy football drafting for both the regular season and playoffs is similar in that you want to take the NFL players that get the most touchdowns and the best stats in turn for rewarding you with higher points. The team with the most collective points wins! However, playoff fantasy drafting is much different than a regular season fantasy draft, with the key difference being one doesn’t know how many games that a player will actually play! Patrick Mahommes may be the best player available per game on paper; but if his KC Chiefs lose in their first game, a middle-of-the-road player like Julian Edelman from the Patriots who is expected to play multiple games, can be superior. Thus, the key is trying to pick not only the best available player, but also the one who will play the most games.

It’s sort of like investing, where picking NFL players and their teams become synonymous with picking companies. You want a collective bunch of players/securities that outperform others which ultimately leads to higher values. I looked at this draft pool of players like I would constructing a portfolio: diversifying my picks by player positions and teams.

Some of the other owners didn’t follow this disciplined approach, instead opting at throwing all of their marbles into the fate of one team and hoping it would lead them to the Fantasy Football Holy Land. And just like investing all or the majority of your dollars into one stock, this type of “coaching” can lead to utmost failure. Case in point: one owner loaded up on one team, taking several players on the Houston Texans. Ouch. (If you’re an NFL fan, you know that the Texans were squashed by the Colts and are out of the playoffs, just like this “owner” is now out of contention in our Fantasy League!) The morale of this story is: there is no silver bullet in football or investing; stay disciplined and diversified and reap the rewards over the long term.

And now onto the year-end market commentary…

Unfortunately, there were not many good draft picks this year. In fact, as stated in one of our previous blogs, around 90% of asset styles were in the red this year. And I don’t mean the Red Zone! Let’s see how the major asset classes fared in 4q18 and calendar year 2018:

Equities: Stocks were driving down the field, reaching record highs right before the 4th quarter began and then…well, let’s just say: “FUMBLE!” with the MSCI AC World Index & the S&P500 both dropping over 13%! This was the steepest annual decline for stocks since the financial crisis. Yes, investors were heavily penalized in 4Q18 for several infractions, the biggest being:

  • The slowing of economic growth
  • The ongoing withdrawal of monetary policy accommodation, i.e. the Fed raising rates and until recently, signaling more raises to come
  • Trade tensions continuing to escalate
  • The uncertainty of a prolonged US Government shut-down
  • Geopolitical risk

None of these risks above justify the severe market sell-off, which brought the MSCI AC World Index to a -10.2% return for 2018. This is in stark contrast to 2017, when it was up 24.0%! “Turnover!” Frankly, the stock market probably overdid it on the upside then and now has overdone it to the downside.

Fixed Income: The Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index “advanced the ball” in the fourth quarter, up 1.6% and 1.2%, respectively. Still, it wasn’t enough to produce any “first downs” with the US Agg essentially flat and the Barclays Global down 1.2% on the year. Bad play: In December, the Fed raised rates another quarter-point and indicated they may do more. Good play: within the last week, they may have completed the equivalent of a “Hail Mary” by signaling a much more dovish stance – it certainly made the stock market happy, now up 7 out of the last 9 days at the time of this writing.

Alternatives:  Like an ordinary offense playing against the mighty Chicago Bears D, alts were “sacked” in the fourth quarter as evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, falling 4.0% for the quarter and finishing the year down 5.1%. This is the worst showing ever for this alternative benchmark. Frankly, we are shocked with this draw-down, chalking it up to 2018 going down as the year where there was no place to hide. Gold*, Managed Futures**, and Merger Arbitrage*** proved to be good diversifiers in 4q18, up 7.5%, 3.6%, 2.4%, respectively; but not many “W’s” (aka “wins”) for the year in alts or any asset class for that matter.

Put it all together and a balanced investor is looking at negative single-digit percentage losses on the year. Yes, 2018, in particular the fourth quarter, was a brutal one for investors. It was like we were in the Red Zone about to score an exhilarating touchdown, only for a “Pick 6” to happen. (Pick 6 is when the football is intercepted and returned into the opposing end zone.) What we learned is that “L’s” (aka “losses”) or corrections can still happen. Going into this year, many had forgotten that markets actually can and do go down. Further, markets can be volatile, down big one day, and up big the next. So what is one to do now, besides putting the rally caps on?

The answer is: essentially nothing. Be disciplined and stay the course. Or, if your asset allocation mix has fallen far out-of-line of your long-term asset allocation target mix, you should rebalance back to target buying in relatively cheap areas and selling in relatively expensive areas. Or, if you happen to have come into cash recently, by all means put it to work into the stock market. This may not be the absolute bottom, but it sure appears to be a nice entry point after an almost 20% decline from top to bottom for most stock indices. From a valuation standpoint, equities haven’t looked this attractive in years, with valuations both here in the US and around the globe below the 25-year average.

And speaking of football, it’s easy to be a back-seat quarterback and say, “maybe we should’ve done something differently” before this latest correction. But we need to remember that empirical studies show that trying to time the market does NOT work. You have to make not just one good decision, but two: when to get out and when to get back in. By pulling an audible and being out of the market for just a few days, one can miss the best of all days as evidenced by the day after Christmas when the Dow Jones went up over 1000 points. In conclusion, if you can take the emotion out of it and stay fully invested through the ups and downs; at the end of your football career, you give yourself the best chance to make it to the Super Bowl.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the iShares Gold Trust

**represented by the Credit Suisse Managed Futures Strategy Fund

***represented by the Vivaldi Merger Arbitrage Fund

Understanding Benchmarks: Why is my Portfolio Trailing the S&P 500 so far in 2018?

Many investors with well-balanced, diversified portfolios might be asking this exact question when they compare their year-to-date (“YTD”) return with that of the S&P 500. To understand the answer to this question is to understand your portfolio composition and your relative performance to a benchmark which may or may not include the S&P 500.

Per Investopedia, “a benchmark is a standard against which the performance of a security or investment manager can be measured. Benchmarks are indexes created to include multiple securities representing some aspect of the total market.” Within each asset class – equities, fixed income, alternatives, cash – you’ll find lots of benchmarks. In fact, the total number of indexes is somewhere in the thousands! That said, “when evaluating the performance of any investment, it’s important to compare it against an appropriate benchmark.” So let’s start by getting familiar with the most popular as well as the most applicable benchmarks out there.

  • Dow Jones Industrial Average: Arguably the most well-known index for domestic stocks, the Dow is composed of 30 of the largest “blue chip” stocks chosen by the editors of the Wall Street Journal. The Dow is not a good benchmark to compare your diversified equity portfolio because 1) 30 companies is a small sample given there are over 3000 publicly listed stocks traded in the US alone. 2) The Dow isn’t well diversified with a heavy influence to industrials and excludes big names like Apple, Amazon, & Berkshire Hathaway. 3) It is price-weighted, meaning a stock with a higher price will have a higher weighting in the index than a stock with a lower price. Change in share price is one thing, but absolute share price shouldn’t dictate measurement. Thus, this index is severely flawed.
  • The S&P 500: Another index for domestic stocks, composed of 500 large-cap companies representing the leading US industries chosen by the S&P Index Committee. It’s certainly not as flawed as the Dow, but it too has its own problems: the biggest being that it is market-cap weighted, meaning that a stock’s weighting in the index is based on its price and its number of shares outstanding. So as a company’s stock price rises and its market-cap grows, this index will buy more of that stock and vice-versa. Thus, the index is essentially forced to buy larger, more expensive companies and sell companies as they get cheaper. This “flaw” is great in times when large cap growth companies are hot: think about FAANG – Facebook, Amazon, Apple, Netflix, Google – these are all stocks that up until recently have soared and essentially the reason why the S&P500 heading into this month was one of the only 10% of 2018 positive areas amongst all of the asset categories Deutsche Bank tracks. (See graph below.) However, the S&P500 won’t show too well when growth is out of favor and investors emphasize value and fundamentals like they did in the 2000s, a decade when the S&P500 had basically zero return.
  • There are many other popular equity benchmarks such as the Russell 2000 (representing small cap stocks), MSCI EAFE (representing international stocks – in particular ones from developed regions of Europe, Australiasia, and the Far East), MSCI EEM (representing stocks of emerging regions), and lots more.
  • All of these above focus on a particular niche within the equity market. Therefore, none of them really make a good benchmark for comparison to your well-balanced, diversified portfolio. It’s like comparing apples to oranges! Which is why we favor the following benchmark for equity comparison purposes: MSCI ACWI (All Country World Index): This index is the one-stop shop for equity benchmarks consisting of around 2500 stocks from 47 countries, a true global proxy. It’s not a perfect benchmark, but it does get you closer to comparing apples to apples.

Next, we look at popular benchmarks within Fixed Income:

  • Barclays Capital US Aggregate Bond Index:  Basically the “S&P500 of bond land” and sometimes referred to as “the Agg”, this bond index represents government, corporate, agency, and mortgage-backed securities. Domestic only. Flaws include being market-cap weighted and that it doesn’t include some extracurricular fixed income categories like floating rate notes or junk bonds.
  • There are others, like the Barclays Capital US Treasury Bond Index & the Barclays Capital US Corporate High Yield Bond Index, that focus on their respective niche, but probably the best bet comparison for most diversified fixed income investors would be the Barclays Capital Global Aggregate Bond Index. This proxy is similar to the “Agg”, but we believe superior given about 60% of its exposure is beyond US borders. Not exactly apples to apples, but it can work.

Lastly, Alternatives:

  • For Alternatives, benchmarks are somewhat of a challenge as there aren’t as many relative to the more traditional asset classes of stocks & bonds because there are so many different flavors and varieties of alternatives. We think one of the most appropriate comparison proxies in alternative land is the Credit Suisse Liquid Alternative Beta Index. It reflects the combined returns of several alternative strategies such as long/short, event driven, global strategies, merger arbitrage, & managed futures. As such, it can be considered as an appropriate comparison tool when comparing your liquid alternative portion of your portfolio.

Now that you’re more familiar with some of the more popular and applicable benchmarks of each asset class category, you may be asking the question: which one of the above is the best for comparison to my portfolio? The answer is: none of them alone, but rather a few of them combined. In other words, you would want to build a blended proxy consistent with the asset allocation mix of your portfolio. For example, if your portfolio is 50% equities / 30% fixed income / 20% alternatives, then an appropriate blended benchmark might be 50% MSCI AWCI Index / 30% Barclays Capital Global Aggregate Bond Index / 20% Credit Suisse Liquide Alternative Beta index. Now you’re really talking an apples-to-apples comparison!

You now should be equipped on how to measure your portfolio versus an appropriate benchmark. With 90% of assets categories being down for 2018 according to data tracked by Deutsche Bank through mid-November (see graph below), most likely you are sitting at a loss for 2018. 2018 has been a challenging year for all investors. Besides a select group of large cap domestic names (that are big constituents of the S&P500), most investment areas are down. That 90% losing figure is the highest percentage for any calendar year since 1920! Yikes! This also could be the first year in over 25 that both global stocks and bonds finish in negative territory. Wow! It’s a tough year. Not every year is going to be a positive one, but history shows that there are more positive years than negative ones. Stay the course.

Our investment management team here at DWM is made up of CFA charterholders. As such, we believe in prudent portfolio management which adheres to a diversified approach and not one that takes big bets on a few select areas. We know that with this diversified approach, it’s inevitable that we won’t beat each and every benchmark year-in and year-out, but we can be capable of producing more stable and better risk-adjusted returns over a full market cycle. Further, we are confident that our disciplined approach puts the client in a better position to achieve the assumed returns of their financial plans over the long run, thereby putting them in a position to achieve much sought long-term financial success.

Have fun with those comparisons and don’t forget to lose the oranges and double up on the apples!

DWM 3Q18 MARKET COMMENTARY

Get yourself fit! A diversified portfolio is like a well-balanced diet. You need all major asset classes/food groups for proper nutrition. Think of the major asset classes (equities, fixed income, alts) as your protein, carbs, and fats. If you were to load up in one particular area (e.g. carb loading), you might feel better in the short-term, but it could seriously affect your health in the long-term. And it’s the same way with investing: if you “overindulged” in any one particular area for too long; you are bound to get ill at some point. Which is a good segway for this quarter’s market commentary. Yes, US stocks – those in the large cap growth area in particular – ended the third quarter near records, but now is not the time to be one-dimensional.

But, before we dive into a proper nutritional program, let’s see how the major asset classes fared in 3q18:

Equities: Let’s start with the spicy lasagna…the S&P500, the hot index right now, which climbed 7.7% in the quarter and up 10.6% for the calendar year. However, most don’t realize that just three companies (Apple, Amazon, & Microsoft) make up one-quarter of those year-to-date (“YTD”) gains. Besides these outliers, returns in general for equities are more muted as represented by the MSCI AC World Index registering a 3.9% 3q18 & 3.65% YTD return. Emerging Markets* continue to be the cold broccoli, down 1.1% for the quarter and now -7.7% for the year. In other words, even though the headlines – which like to focus on domestic big-cap stocks, like the ones in the S&P500 and Dow – are flashing big numbers; in reality, the disparity amongst equity benchmark returns is huge this year with some areas up sizably and some areas down sizably.

Fixed Income: The Barclays US Aggregate Bond Index, was basically unchanged for the quarter and down 1.6% YTD. The Barclays Global Aggregate Bond Index fell 0.9% and now down 2.4% YTD. Pretty unappetizing. The shorter duration, i.e. the weighted average of the times until the fixed cash flows within your bond portfolio are received, the better your return. It’s a challenging environment when interest rates go up, but the Fed continues to do so in a gradual and transparent manner. Last week, the Fed raised its benchmark federal-funds rate to a range between 2% and 2.25%. We could see another four rate hikes, one for each Fed quarterly meeting, before they stop/pause for a while.

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, increased +0.7% for the quarter and now off only 1.2% for the year. Alts come in many different shapes and forms so we’ll highlight just a few here. Gold** continued to drop, down 4.9% for qtr and now off 8.6% for year. Oil*** continues to rise, up 4.7% 3q18 & 27.5% YTD. MLPs**** jumped 6.4% on the quarter and now +5.0% for 2018. Whereas alts have not been “zesty” as of late, think of them like your morning yogurt: a great source of probiotics, a friendly bacteria that can improve your health when other harmful bacteria emerge.

So after a decent 3q18 for most investors, where do we go from here and what should be part of one’s nutritional program?

Let’s first talk about the economy. It’s been on a buttery roll as of late. The Tax Cut & Jobs Act of 2017 has created a current environment for US companies that has rarely been more scrumptious, as evidenced by earnings per share growth of 27% year-over-year (“YOY”). Unemployment clicked in at last measure at 3.9% and most likely will continue to drop in the near future. With the economy this strong, many may find it surprising to see the lack in wage growth and inflation. Wages are only up 2.8% and core inflation is up only up 2.0% YOY. Wages are staying under control as the Baby Boomers and their higher salaries exit the work field, replaced by lower-salaried Millennials and Gen Z. Part of the lack of inflation growth is because of the internet/technology that gives so much information to the Buyer at the tip of their fingers, keeping a lid on prices. Trade talk/tariffs, have been a big headliner as of late creating a lot of volatility; but that story only seems to be improving with the revised NAFTA taking shape with Mexico and Canada. Some type of agreement with China could be on the near horizon too.

This is all delectable news, but the tax stimulus effect will peak in mid-2019 and companies will have to perform almost perfectly to remain at their current record profit margin levels. With earnings a major component of valuation, any knock to them could affect stock prices. Further, the S&P500 is now trading at a forward PE ratio of 16.8x, which is north of its 16.1x 25-year average. This is not the case in other areas of the world – Europe, Japan, Emerging Markets – where valuations are actually lower than averages. If you haven’t done so already, time to put those on your menu.

It’s not only a good diet you want for your portfolio; you also want to make sure of proper fitness/maintenance, i.e. rebalancing back to established long-term asset allocation mix targets. Time to bank some of those equity gains and reinvest those into the undervalued areas if you haven’t already done so recently. Regular portfolio rebalancing helps reduce downside investment risk and instills discipline so that investors avoid “buying high” and “selling low”, a savory way to keeping you and your portfolio healthy.

In conclusion, we are in interesting times. The economy is peppery-hot, but incapable of keeping this pace. A slowdown is inevitable. The question is two-fold: how big will that slow-down be, and are you prepared for it? Now is the time to revisit your risk tolerance and compare that to how much risk is in your current portfolio. That spicy lasagna, aka the S&P500, has been a delicious meal as of late, but don’t let too much of it ruin your diet. Make sure your portfolio is diversified in a well-balanced manner. Stay healthy and in good shape by working with a wealth manager like DWM who can keep your portfolio as fit as a triathlete.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the MSCI Emerging Markets Index

**represented by the iShares Gold Trust

***represented by the Morningstar Brent Crude Commodity ER USD

****represented by the UBS AG London BRH ETracs Alerian MLP ETF