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

DWM 2Q18 MARKET COMMENTARY

‘Confusing’. If you look that word up in a dictionary, you’ll see something like “bewildering or perplexing” as its definition. Confusing could be a good way to describe the state of the market. On the one hand, you have a U.S. economy that may have come off one of its strongest quarters in years. On the other hand, there is continued threat of higher interest rates and a tumultuous trade war.

Before looking ahead, let’s see how the major asset classes fared in 2Q18:

Equities: Stocks were mixed in 2q18. Certain pockets did well whereas certain ones did not. For example, the Dow Jones Industrial Average Index was down 0.7% on the quarter and now in the red for the 2018 calendar year (-1.8%). The Dow’s multinational holdings are more prone to trade-related swings, whereas small caps*, up 7.8% for 2q18 & 7.7% YTD (Year-to-date as of 6/30/18), are not. Emerging stocks**, -8.0% 2q18 & -6.7% YTD, did not fare well. This brewing trade war between the U.S. and China, along with rising interest rates and the rising U.S. dollar, are causing many investors to flee from these so-called riskier areas. We think a good general proxy for global equities is represented by the MSCI AC World Index, which was up a modest 0.72% for the quarter, and now about flat (-0.2%) for the year.

Fixed Income: Yields continued to go up, boosted by the same concerns as last quarter: increasing expectations for growth and inflation in the wake of the recent $1.5 trillion tax cut. The Barclays US Aggregate Bond Index, dropped a modest 0.16% for the quarter and now down 1.6% YTD. TheBarclays Global Aggregate Bond Index fell 2.8% (and now down 1.5% YTD) as emerging market bonds suffered for same reasons as mentioned above for emerging market equities.

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, registered a +0.4% for 2q18 and now off only 1.3% for the year. Gold*** suffered, -3.5%, however REITs**** and MLPs† had nice quarter returns of 5.8 and 11.5%, respectively.

Like others, you may be thinking something like this right now: “Thank you for providing color on the various assets classes, but I’m still confused. How did a balanced investor fare overall? And where do we go from here?”

Overall, most balanced investors had modest gains for 2q18 and are pretty close to where they were when they started the year.

As for looking forward, we think the area causing the most confusion and uncertainty is the tariff trade war issue. A lot of this is political noise which has weighed down stock prices. What has been, or will be, enacted is quite different than what is being discussed. We are hopeful that the countries can eventually reach a compromise on trade.

In the meantime, the US economy is red hot, with GDP nearing 5.0% and unemployment levels near lows not last seen since 1969. The upcoming earnings season should be exquisite! But all of these positives get analysts worried that the economy may overheat. The Fed’s goal is to raise interest rates enough to keep enough pressure on the brakes of this economy to control inflation, but not too much where it comes to a screeching halt. That being said, inflation is a little bit above the Fed’s target level and as such we would expect to see the Fed continue to raise rates gradually, perhaps for the next 4 -5 quarters. They’ll most likely need to stop at some point as the economy cools when some of the Tax Reform stimulus wears off in the second half of 2019. It’s not an easy job.

“I’m still confused – should we be worried about a recession in the near future?” While we don’t see it happening any time soon, it definitely is an increased possibility, and at some point, will inevitably occur. The goal is to be prepared for it. Don’t let emotions get in the way. Stay diversified and stay invested. Trying to time the market is a losing proposition. A good wealth manager can help you stay disciplined.

The good news is that the next recession will most likely be milder than the last couple for a few reasons including the following:

  • Economies, both here and abroad, are simply more stable than in the past.
  • Valuations are fine today. The forward 12-month PE (Price-to-Equity Ratio) of the S&P500 is right in-line with its 25-yr average of 16.1. International stocks, as represented by the MSCI ACW ex-US Index are even cheaper, trading at a 13.0 forward PE.
  • The Fed certainly does not want another 2008 on its hands. They will continue to be friendly to market participants.

SP GRAPH EDITED

 

Still confused? Hopefully not. But if you are, talk to a wealth manager like DWM. If you look at antonyms for confusion, you will see words like “calm”, “peace”, and “happiness”. That’s what our clients want and what we seek to provide them.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

**represented by the Russell 2000 Small Cap Index

**represented by the MSCI Emerging Markets Index

***represented by the iShares Gold Trust

****represented by the iShares Global REIT

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

DWM 1Q18 Market Commentary


In our last quarterly commentary, we cautioned not to get complacent, overconfident, or “too far out over your skis”. It’s ironic how just three months later, many investors’ emotions are just the opposite: unsure, cautious, and even scared. And rightly so, given the extreme up and downs for the first quarter of 2018. The stock market was in a classic “melt-up” state in January, only to quickly drop into correction territory in early February, then bounce and fall and bounce again from there. Yes, as I mentioned in my February 12th blog, volatility is back and here to stay (at least for the near future)!

Before looking ahead, let’s see how the major asset classes fared in 1Q18:

Equities: The S&P500 had its first quarterly loss since 2015, falling 0.76%. On the other side of the globe, developed countries also suffered, evidenced with the MSCI AC World Index registering a -0.88% return. Emerging markets were a stand-out, up 1.28%*. In a turn of events, smaller caps significantly outperformed larger caps. Much of this has to do with the trade war fears, i.e. many feel that smaller domestic companies will be less affected than some of the bigger domestic companies that rely on imports. Growth continued to outperform value. However, that gap narrowed in the last couple of weeks with some of the biggest cap-weighted tech names getting drubbed, including Facebook because of their user-data controversy and Trump’s monopolistic tweets at Amazon.

Fixed Income: Yields went up, powered by increasing expectations for growth and inflation in the wake of the recent $1.5 trillion tax cut. The yield on the 10-year Treasury note rose from 2.4% to 2.7%. When bond rates go up, prices go down. So not surprising the total return for the most popular bond proxy, the Barclays US Aggregate Bond Index, showed a 1.46% drop. Fortunately, for those with international exposure, you fared better. The Barclays Global Aggregate Bond Index rose 1.37%, helped by a weakening U.S. dollar (-2.59%**) pushing up local currency denominated bonds.

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was down 1.72%. Losers in the alternative arena include: trend-following strategies, like managed futures (-5.08%***), that don’t do well in whipsaw environments like 1Q18, and, MLPs, which were under duress primarily due to a tax decision which we think was overdone. Winners include gold****, which was up +1.76% for its safe haven status, and insurance-linked funds† (+1.60%), which have hardly any correlation to the financial markets.

In conclusion, most balanced investors are seeing quarterly losses, albeit small, for the first time in a while. So where do we go from here?

Inflation concerns were the main culprit to the February sell-off, but there are other concerns weighing upon the market now: fears of a trade war brought on by tariffs, escalated scrutiny of technology giants, new Fed leadership, increasing interest rates, stock valuation levels, and a bull market long in the tooth in its 10th year.

Opposite these worries is an incredibly hot economy right now, supported by the tax cut which should boost corporate earnings to big heights. In fact, FactSet has projected earnings for S&P500 companies to increase 17% in 1Q18 from 1Q17!

And, whereas there has been much dialogue regarding how the S&P500 has been trading at lofty valuations, the recent move of stock prices downward has really been quite healthy! It has put valuations back in-line with historical averages. In fact, the forward 12-month PE (Price-to-Equity Ratio) of the S&P500 at the time of this writing is almost identical to its 25-yr average of 16.1. International stocks, as represented by the MSCI ACW ex-US is even more appealing, trading at a 13.3 forward PE.

We don’t think inflation will get out of hand. Even with unemployment around all-time lows, wage growth is barely moving up. So we doubt that we’ll see inflation tick over 2¼%. That said, we do think the Fed will continue to raise rates. Frankly, they need to take advantage of a good economy to bring rates up closer to “normal” so that they have some fire-power in the event of future slow economic times. But that doesn’t mean they’ll be overly aggressive. The new Fed Head, Jerome Powell, like his predecessor, most likely will be easy on the brakes, keeping focus on how the Fed actions play off within the market.

Put it all-together and it seems like we’re in a tug-of-war of sorts between the positives and the negatives. At DWM, we feel like the positives will outweigh the negatives and are cautiously optimistic for full year 2018 returns in the black, but nothing can be guaranteed. The only couple things one can really count on are:

1.Continued volatility. After an abnormally stable 2017 that saw little whipsaw, 2018’s volatility is more reminiscent to the historical average of the last few decades. Back to “normal”.

2.DWM keeping its clients informed and embracing events as they unfold, keeping portfolios positioned and financial plans updated to weather what’s next.
Here’s looking to what 2Q18 brings us!

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

*represented by the MSCI Emerging Markets Index

**represented by the WSJ Dollar Index

***represented by the Credit Suisse Managed Futures Strategy Fund

****represented by the iShares Gold Trust

†represented by the Pioneer ILS Interval Fund

COMPLACENCY CHECK: MARKETS FINALLY GO DOWN & THE RETURN OF LONG OVERDUE VOLATILITY

 

The last week hasn’t been kind to investors. The S&P500 and Dow officially entered “correction” territory, which signifies a decline of at least 10% from a recent high, after all-time record highs only a couple weeks ago.   What’s going on???

 

The culprit: things were too good!  Recent stronger than expected reports on wages and jobs means growth may be “overheating” and that can lead to inflation and rising interest rates. Rising rates equal higher bond yields, which can make bonds more attractive than stocks, and – VOILA! – now traders don’t want to own stocks, many of which have become quite expensive on a valuation perspective from the nine-year Bull run. Then, in this worst-case scenario, stocks go down and that causes consumer confidence to wane which means Joe Investor won’t want to be another 4G TV. Consumer spending slows, corporate earnings suffer, and recession takes place.

 

Vicious circle, huh? It doesn’t have to be exactly like that. Furthermore, cycles can take a long time to play out – years, not days. In this fast-paced, information at your fingertips society we’re in, we forget that.

Last Friday’s jobs report showed the largest annual increase in wages since 2009. In hindsight, this wasn’t surprising given that 18 states pushed up minimum wages to start 2018. Furthermore, many major corporations, raking it in from the recent tax cuts, have provided one-time Tax Reform-related bonuses to workers. So these government reports, that some traders obsess over, may have been amplified for January and most likely will come down to earth in the ensuing months.

 

It was just a couple of years ago when many were concerned about DEFLATION and hoped of the day when the Fed could raise rates back to “normalcy”. This schizophrenic market is now focused on the fear of INFLATION. The threat of inflation and higher bond yields – evidenced by the Ten-Year Bond reaching four-year highs yesterday at 2.85% – has some worried. But frankly, a 3% or even 4% Ten-Year Bond environment shouldn’t be so concerning. For the last several decades, the 10-Year was higher than that and could be nice “fresh powder” for a Fed when recessionary times come.

 

The “buy the dip” mentality that has been so common place the last few years has not shown up this time around, or at least not until today. Some contend that “buy the dip” investors didn’t have enough time as the quants and hedge funds with big volatility-related bets work through the crash in that subsector.

After a very calm 2017 where we didn’t see any stock markets daily moves of over 2%, we’ve already had a few this year. Volatility is back to “normal” – not 2017 normal, but normal when we are comparing to the last 100 years or so. It was only February of 2016 when we had our last correction, which really isn’t that long ago. But complacency is unfortunately an easy characteristic to exhibit after such a long period of subdued volatility. Hopefully it didn’t lead to overconfidence.

So we’re in a correction…what do we do now?

 

There have been over a dozen market pullbacks of 5% or more since March 2009. This is another one! According to Goldman Sachs Chief Global Equity Strategist Peter Oppenheimer within a January 29 report, “The average bull market ‘correction’ is 13% over four months and takes four months to recover.” Which tells you that generally when the market comes back, it does so relatively quickly, as we’ve already seen today.

 

So, it’s a fool’s game to try to time the market and jump in and out of it. No one has a crystal ball. Furthermore, we know that over time that staying invested is your friend. Studies show that just missing a few days of strong returns (which we could very well get next week or later this month), can drastically impact overall performance.

So avoid any emotional mistakes by staying invested and staying disciplined. Don’t be making any short-term knee-jerk reactions; instead think long-term and focus on the 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

 

In closing, a pullback / correction like this one is needed to allow the market to recalibrate. It can be a very healthy event because it may signify that the underlying assets’ valuations are getting back in line with fundamentals. So don’t get anxious over this return of long overdue market volatility. We should all get used to this “new normal” and not let our emotions cause us to take irrational actions that could lower our long-term chances of financial success.

 

Don’t hesitate to contact us to further discuss your portfolios and your overall wealth management.

 

[1] Cheng, Evelyn. “The stock market is officially in a correction… here’s what usually happens next.” CNBC, 8 February 2018, https://www.cnbc.com/2018/02/08/the-stock-market-is-officially-in-a-correction–heres-what-usually-happens-next.html. Accessed 12 February 2018.

DWM 2017 YEAR-END MARKET COMMENTARY

Ah, winter…colder temps, snow (even in the Carolinas)…it’s a good time for the annual ski trip. But if there are words for caution when skiing, it’s always: “Don’t get too far out over your skis!” Something for investors to think about as we talk about how the markets fared in 2017 and where they might go in 2018.

Equities: “Fresh powder!” In concerted fashion around the globe, equities rallied in 2017, thanks to strong economic fundamentals and friendly central bankers. Almost like Goldilocks’s time, where the porridge is not too hot nor too cold, so is the pace of this economic expansion: fast enough to support corporate earnings growth, but slow enough to keep the Fed from putting the brakes on too quickly. This led to a magic carpet ride for equity investors, with returns of 5.1% for 4q17 & 18.3% YTD for the average diversified US stock fund* and a 4.1% fourth quarter return and a hearty 26.8% YTD for the average international stock fund*. “Gnarly!” Growth outperformed value, with a handful of tech stocks (Apple, Microsoft, Alphabet, and Facebook) leading the way. But it should be noted that this won’t last forever. In fact, a 2016 study** showed that the average annual price return for growth stocks to be only 12.8% vs 17.0% for value stocks. Another reason to be diversified.

Fixed Income: It was also a positive time for bond investors, as evidenced by the Barclays US Aggregate Bond Index gaining 0.4% in the fourth quarter and 3.5% for the year. The inclusion of global fixed income assets led to better results with the Barclays Global Aggregate Bond Index registering +1.1% for 4Q17 and +7.4% YTD. Yields on the ten-year bond pretty much finished the year where they started, with investors content with the Fed’s pace of raising rates.

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 1.7% for 4q17 and 4.6% YTD. Two of the most well-known alternative exposures, gold and real estate, had solid showings for both the quarter and the full year. Gold***: +1.6% and 12.9%, respectively. Real Estate****: +3.5% and 7.8%, respectively.

2017 proved to be another rewarding year for the balanced investor. But how do the slopes look for 2018? Will it be another plush ride up the mountain again? Gondola, anyone?!?

Indeed the same items – low interest rates, low inflation, accelerating growth, strong earnings – that propelled the global economy in 2017 should remain in 2018. The risk of recession seems nowhere in sight. Furthermore, the Republican tax overhaul is also expected to be a boost, at least in the near-term. But not sure if that represents “eating tomorrow’s lunch”. Moreover, two key drivers of economic growth, productivity gains and labor force expansion, have been on the downtrend. So is now the time to be thinking about the “vertical drop”???

With the bull market in its ninth year, many areas of the stock market at record highs, and volatility near record lows, it can be easy to become not only complacent but overconfident. Now is not the time to get too far out over your skis and take on more than you can chew! At some point, the fresh powder will turn into slush. Don’t be a “hot dog” or a “wipe-out” may just be in your future.

At DWM, we see ourselves as ski instructors, helping our skiers traverse the green, blue, and even black diamond runs by keeping them disciplined to their long-term plan, including the allocation and risk profiles of their portfolios. Rebalancing, the act of selling over-weighted asset classes† and buying underweighted asset classes in a tax-conscious manner, is part of our ongoing process and prudent in times like these. There are few signs of financial excess like ten years ago, but the market can only be predictable in one fashion: that it’s always unpredictable.

In conclusion, may your 2018 be a ‘rad’ one, with fresh powder on the slopes and fireside smiles in the cabin. Don’t hesitate to contact us if you want to talk or ‘shred’ the nearest run.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

*according to Thomson Reuters Lipper

**study by Michael Hartnett of Merrill Lynch

***represented by the iShares Gold Trust

****represented by SPDR Dow Jones Global Real Estate

†versus your initial investment target

Time for a financial caddie?

Caddie_Brett.jpg

“Pro Jock.” “Looper.” That’s what I strived to be in my early days of youth. Those that are familiar with the movie Caddyshack may recognize the reference and, yes, one of my first jobs was that as a caddie. And whereas the Caddyshack movie was quite whacky, in real life the lessons learned by growing up as a golf caddie were life lessons and things as a “financial caddie” I still exhibit today.

  1. Preparation / Guidance – a good golf caddie (“GC”) should arrive to the ball before the golfer and remove any surrounding debris and have yardage-to-the-green ready for the golfer. This is quite similar to how a financial caddie (“FC”) prepares his client for the next big shot in their life, by assessing the current investment environment and creating an Investment Policy Statement/target asset allocation mix and chart of course that can help the client navigate “all 18 holes”.
  2. Paying attention – a good GC needs to be paying attention to their golfer’s needs, i.e. is she cold and needs a jacket from the bag?, is her ball dirty and in need of cleaning?, is she familiar with what the next hole does? A good FC is one that is not only paying attention but being proactive with the client’s needs, i.e. running tax projections to make sure there are no surprises come tax time, running estate planning flow reports to make sure that the clients’ estate planning is in-line with their wishes, etc.
  3. Commitment – I remember some caddies that would quit – sometimes physically, sometimes mentally, sometimes both – out there. That’s bad caddying and a lack of commitment and perseverance. Some days will be beautiful, sunny ones but some will be stormy with difficult conditions. Like a good GC, a good FC makes you, the client, the priority and makes sure that our professional attention, focus and best efforts always have you in mind.
  4. Resourcefulness – Every “loop” is different, every golf shot is different, every round is different the same way in the financial world there are always new things being thrown at you. A good GC and FC will embrace change and always look for new possibilities to solve the problem, unravel the puzzle, and complete the task.
  5. Attitude – the good caddies know that they need to show up to the caddie shack early in the morning with a smile and a hard-working, respectful attitude if they want to earn the continual right of “toting the bag”. At DWM, one of our most valued qualities is a conscientious attitude used to apply diligence for the timeliness of project completion and adherence to punctuality in schedules in respect to the clients we gratefully

That being said, I’d like to share a wonderful experience with you. Schwab & Co invited my father/business partner, Les, to play in the Schwab Cup Senior Pro-Am last week. Pros like Bernard Langer, Vijay Singh, Fred Couples, Lee Janzen, and our new favorite, Brandt Jobe were all there. These are golfers my dad grew up watching and idolizing. Les was able to share the course with these guys and, after a 20+ year break, I came out of golf caddie retirement to strap on the bag one last time!

“So, I tell them I’m a pro jock, and who do you think they give me?” No, not the Dalai Lama, but Les Detterbeck, himself. Third generation of the first Lester. The long putter, the grace, not yet bald… striking. So I’m on the first tee with him. I give him the driver. He hauls off and whacks one – big hitter, the Lester – long, into a one foot crevice, a couple miles east of the bottom of the desert, right on the fairway. And do you know what the Lester says? Gunga galunga…gunga…No, actually he says, “give me the 4 wood” and the Lester proceeds to put it onto the green and two putt for a gross par, net birdie to start our Pro-Am team off in the right direction.

Brett-Les.jpg

It was exhilarating day to say the least. We didn’t win the event, but we had a once-in-a-lifetime day, coming just a couple weeks before Les’ 70th birthday. And whereas I doubt I will ever caddie for someone in an official tournament ever again, I know that I will always strive to do my best as a FINANCIAL CADDIE to the wonderful clients we currently serve and future ones.

Of course, this was the first time I had officially caddied in over twenty years. I thought I did a splendid job, my gift to Les for his 70th. Back in the 80’s, I’d be happy to earn $20-$40 for the round to go blow at the local music shop on a few CDs. But this time… there was no money; only total consciousness. So I got that going for me, which is nice.

(*If you haven’t figured by now, Caddyshack is the author’s favorite move of all time. Happy BDay, Les! Gunga Galunga!)

DWM 3Q17 Market Commentary

“Train Kept A Rollin’ All Night Long…” The US economic expansion continued on during the third quarter of 2017. It is the third longest expansion since World War II and is now closing in on 100 months.  There were plenty of negatives that tried to slow it down. Politically, we had the debt ceiling deadline, a failed attempt to repeal Obamacare, and a war of words with North Korea. Even the lives and economic losses from the likes of Hurricane Harvey, Irma, Maria, western wildfires and two Mexican earthquakes – amounting to what could be the most expensive year for natural disasters ever – couldn’t slow this train down.

Thing is: the positives outweigh those negatives. At the end of the day, the market is powered by companies’ earnings. And those earnings have been robust and are expected to continue to be! And it’s not just domestically; growth is accelerating at a global level with Eurozone businesses and households more confident about their prospects than at any time in more than a decade. Japan has shown decent growth and inflation this year. And emerging markets are enjoying better fundamentals with more credible politics. Choo! Choo!

We are big believers in asset allocation which is why we showcase the major asset classes each quarter. Here’s how each fared:

Equities: The S&P500 rose 4.5% on the quarter and is now up 14.2% year-to-date (“YTD”). Sounds excellent, but actually a more diversified benchmark, the MSCI All Countries World Index, which includes US large cap stocks, US smaller cap stocks AND international stocks, did much better, up 5.3% quarter-to-date (“QTD”) and now up 17.3% YTD. We’ve been saying for some time that domestic large cap stocks in general look pretty “frothy” and hence it’s not surprising to see this rotation out of domestic large cap stocks into other cheaper equities. The other thing at play is the renewed interest in the so-called “Trump trade”. The areas that moved post-Trump Presidential Election, like small cap and value, have ‘steamed ahead’ in the last few weeks from the renewed hope of possible tax cuts. In just September, the Russell 2000 outperformed the S&P 500 by 4.2% and the Russell 3000 Value outperformed the Russel 3000 Growth by 1.6%.

Fixed Income:  During the quarter, the Fed announced that they are pushing ahead with an aggressive schedule for rate increases. We are happy to see the Fed take this path toward “normalization” while the economy is strong. The US needs to get back to higher rates so that the Fed has “some coal for their engines” if things go bad. That said, this announced path has succeeded in boosting inflation expectations, which has pushed up yields in both the 2-year and 10-year US Treasury notes, with the latter closing the quarter at 2.3%, its first quarterly gain of 2017. For the record, the Barclays US Aggregate Bond Index gained 0.9% in the third quarter and is now up 3.1% for the year. The inclusion of global fixed income assets led to better results with the Barclays Global Aggregate Bond Indexregistering +1.8% for 3Q17 and +6.3% YTD.

Alternatives:  Let’s take a look at a few ‘alts’ we follow. Gold gave back a little in September, but registered a +3.1% 3Q17 return represented by the iShares Gold Trust. With 2017 going down as one of the worst natural disasters year on record, the alternative exposure to reinsurance-linked securities (sometimes referred to as ‘catastrophe’ securities) took a hit. One would have thought oil would have suffered from the hurricanes as well, but demand was strong and with slowing US production, oil prices (WTI) ended the quarter up 12.2%. For the record, the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 1.6% for the third quarter and 2.8% YTD.

For balanced investors, It’s been a pretty nice three quarters to start 2017. Looking forward, this bull market train can continue to roll, and a case can be made that returns can even get stronger given the great economic fundamentals around the globe. If Washington can get something done relative to a tax cut, look for stocks to accelerate into year-end.

Of course, there will always be (rail) road blocks. We are thrilled to see inflation measures move toward the Fed target range around 2%, but there are many out there concerned that inflation might ‘chug’ right through those target levels and create havoc on the back-end. Furthermore, the announced and about-to-start-very-soon Federal balance sheet reduction is an unprecedented experiment. And it’s not just the US attempting this.  Global central banks at some point need to do some house-cleaning and will be reducing their balance sheets as well. There is a huge risk something can go wrong and send this train off track. Lastly, we don’t think the markets are adequately pricing in the geopolitical risk out there, which some would say is approaching multi-decades high. Frankly, when a small probability risk is hard to price in, the market usually just shrugs it off. With trading activity so light recently and little risk currently priced into the market, things could get ugly very quickly if anything goes wrong.

In conclusion, these are challenging times. It’s not easy to navigate the terrain out there. So make sure you have good direction and management. Don’t fall victim to a bad conductor and wind up like Ozzy Osbourne “going off the rails of a crazy train!” Make sure that your engineer is keeping you on track. At DWM, we engineer our clients’ portfolios to ride safely through the peaks and valleys that this train has and will travel through. With the right team at the controls, you can make your journey a pleasant one.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

DWM 2Q17 Market Commentary

“Let the Good Times Roll!” Yes, the 1979 song by Ric Ocasek and the Cars may describe the market’s attitude in the first half of 2017. “You Might Think” the markets are “Magic” or “All Mixed Up” – other classic Cars songs – but, nonetheless, investors should be pleased to see their mid-term results.

With the trading year half-way complete now, “It’s All I Can Do” to give you the major market stories in 2017:

  1. 1.All three major non-cash asset classes (equities, fixed income, and alternatives) are positive to start the year.
  2. 2.Large-cap equities have significantly outperformed small-cap equities, the largest outperformance to start the year in almost 20 years. Large caps, as represented by the S&P500, were up 3.1% for 2Q17 and up 9.3% Year-to-date (“YTD”) through June 30th. Small caps, as represented by the Russell 2000, were up 2.5% and 5.0%,
  3. 3.Growth is significantly outperforming value. In fact, it’s the biggest outperformance to start a year ever besides 2009. The S&P500 Growth Index was up 4.4% 2Q17 & 13.3% 1H17 vs the S&P500 Value Index, up 1.5% and 4.9%, respectively!
  4. 4.International stocks are outperforming domestic stocks. The last several years have seen the opposite, but now international is outperforming domestic in what may be a tidal change. The MSCI EAFE Index was up 6.4% for the second quarter and now 13.8% YTD!
  5. 5.Minimal volatility – Despite political noise and other headlines around the world, the equity market continues to move forward with little whipsaw. The CBOE Volatility Index, Wall Street’s so-called “fear gauge”, saw its lowest level in over two decades!

Let’s drill down into the various asset classes.

Equities: Obviously, we can see from above that returns in ‘equity land’ were quite decent. In general, stocks rallied on strengthening corporate earnings, improving economies both here and abroad, and continued support from central banks. Earnings from S&P500 companies increased 14%, the best growth since 2011.

Fixed Income: The Barclays US Aggregate Bond Index gained 1.5% in the second quarter and is now up 2.3% for the year. The Barclays Global Aggregate Bond Index produced even better returns, +2.6% 2Q17 and +4.4% YTD, thanks to stronger results overseas. Many bond investors, including DWM, have been surprised at the falling US government bond yields. The 10-year Treasury Note started the year at 2.45, peaked in March at 2.61, only to close the quarter at 2.30. Why aren’t rates going up? Much of it has to do with skepticism about the passage of Trump’s fiscal agenda. Amongst other things, there has not been the promised major tax reduction nor a flood of fiscal spending yet. As such, inflation expectations weakened in June. However, hawkish comments in the last several days from major central banks, including our US Fed indicating a strong chance that they will announce in September a decision to start shrinking its balance sheet, has caused a reversal in bond yields to start the third quarter. We see the Fed continuing to unwind the past years of stimulus via rate hikes or balance sheet reductions in a well-announced, controlled fashion.

Alternatives:  The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 0.4% for the second quarter and 1.1% YTD. This benchmark gives one a good feel for what alternatives did in general. Of course, there are many flavors of alternatives so drilling down into the category can reveal very different results. Furthermore, alternatives can take the form of either alternative assets and/or alternative strategies. “Traditional” alternative assets like gold* and real estate** fared well through the first half, up 7.8% and 3.2%, respectively. However, another “traditional” alternative in oil (a commodity) suffered, falling back into bear territory. US fracking companies continue to pump at lower prices frustrating OPEC’s goal of price stability via OPEC member supply cuts. A couple of alternative strategies fared differently: managed futures*** have shown losses in the first half, down -5.6%; whereas merger arbitrage**** has had a decent gain of 2.2%. These examples show how alternatives behave independently, thereby providing the ability to reduce the volatility of one’s overall portfolio.

It has been a solid first half for most balanced investors. Looking forward, it’s hard to say what path the markets will take. They could continue this nice trajectory upward – did you know that US stocks were up in January, February, March, April, and May? This is significant because, historically, when US stocks are up in the first 5 months of the calendar year, the average return for US stocks for the full calendar year was +28.8%! This first-five-months-up event has only happened 12 times and in all 12 times, the year ended up in double digits!

However, domestic stocks are getting expensive. The S&P500 now trades at 18x projected earnings over the next 12 months, its highest level in 13 years. Overseas stocks are still a relative bargain compared to the US and one of the reasons for their recent and expected-to-continue outperformance. Furthermore, where the US has raised short-term interest rates four times since the end of 2015, international central banks have been and will remain relatively more accommodative for the near future.

The other scary thing is that the equity and bond markets are sending mixed signals. If bond yields stay down, that would tell us that the bond market sees tepid economic growth, which could be true if all of the pro-growth Trump agenda plans do not come to fruition. For now, the equity markets are signaling otherwise – that this bull market has legs based upon strong corporate results and improving fundamentals. No, Mr. Ocasek, the signals from the bond market and equity market are not “Moving In Stereo.” Only time will tell to see what market is signaling correctly. In the meantime, the goal is to have a portfolio in place that can weather any storm. At DWM, we think our clients’ portfolios are well-positioned for what the markets will throw at us. We look forward to the journey. In fact, and finishing with one last Cars’ classic, “Let’s Go!”

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

*represented by the iShares Gold Trust

**represented by the SPDR Dow Jones Global Real Estate ETF

***represented by the AQR Managed Futures Strategy Fund

****represented by the Vivaldi Merger Arbitrage Fund

DWM 1Q17 Market Commentary

Did you know that after 146 years, the Ringling Bros and Barnum & Bailey Circus is shutting down? No worries. It seems our friends in Washington are taking it over as it has been a circus-like atmosphere filled with noise for the last few months. Ironically, for the market, it’s been just the opposite, with 1Q17 going down on record as one of the “quietest” quarters in the last 30 years, as represented by the S&P500 posting an average daily move of just 0.32%. But even though the stock market was calm, that does not mean it didn’t produce. Because it did, with the three major asset classes – equities, fixed income, and alternatives – all up.

What’s interesting is that it was not a continuation of the “Trump trade” that has powered the recent advance. After the November election, shares of financials and smaller US stocks jumped based on hopes that looser regulations and tax cuts would benefit banks and more domestically oriented companies. However, so far the Trump administration has not lived up to the campaign hype. The failure of the Republicans’ health-care bill has led investors to question if this administration can push anything through, including any significant shift in U.S. trade policy. That has led to a sector rotation within the equity asset class. Things that were strong post-election like financials and small caps are being sold for US multinationals, particularly those in the trade-sensitive technology sector, and emerging markets. This shows in the following results:

Equities: The MSCI AC World Equity Index had a great start to 2017, up 6.9%. Domestic large cap stocks as represented by the S&P500 came in at a solid 6.1% as large caps dominated small caps*, up only 2.5%. The big winner was emerging markets**, up 11.5%.

Fixed Income: The Fed lifted rates during the first quarter based upon promising US economic forecasts. The personal consumption expenditures price index, which is the Fed’s preferred inflation gauge, ticked in at over 2% for the first time in over five years. It wasn’t too long ago that people were worried about deflation, so this achievement is very good news. The Barclays US Aggregate Bond Index gained 0.8% in the first quarter. The Barclays Global Aggregate Bond Index enjoyed slightly better returns, +1.8%, thanks to stronger results overseas. Again, emerging markets was the place to be, up 4.2% as represented by the PowerShares Global Emerging Mkts Sovereign Debt ETF.

Alternatives:  The Credit Suisse Liquid Alternative Beta Index was just above break-even, +0.1%.  The handful of liquid alternatives (which could be an alternative asset or strategy) that DWM follows fared better. Alternative assets like gold*** surged 8.4% and MLPs**** advanced 2.6%. An alternative strategy like the RiverNorth DoubleLine Strategic Income Fund, which takes positions in the inefficient closed-end space, registered a 1.4% return. The only real losing alternative category we follow were managed futures funds (an example of alternative strategy), like the AQR Managed Futures Fund which lost 1.0%. These funds struggled from the rotation change mentioned above. It should be noted that these type of funds exhibit extremely low correlation to other assets and can provide huge protection in down times.

Put it together and it was a very handsome start to 2017 for most balanced investors.

Looking forward, we are encouraged as we believe economic growth will continue to advance not only in the US but also globally. Consumer and business owner sentiment is very strong. American factory activity has expanded significantly in recent months.

Concerns include:

  • Elevated US equity valuations: Current valuations of 29x cyclically-adjusted price-to-earnings (CAPE) are much higher than the long-term average of 18x. This doesn’t necessarily mean a huge pullback is in front of us, but it could be pointing to a much more muted return profile. Frankly, we would view a small pullback as a healthy development.
  • Pace of Fed rate hikes: We think the Fed has done a decent job handling and communicating rate changes. They need to continue this practice and avoid further acceleration to avoid making investors nervous.
  • The return of volatility: After the record “calmness” mentioned above, volatility most certainly will rise. Hopefully, it advances in a manageable fashion.
  • Heightened Political risk: 2016 was full of political surprises and more are possible in 2017 given the rise in populism and the heavy global calendar. See below.

I’ve written a lot of these quarterly market commentaries and I cannot remember one so consumed with political policy. There’s a lot of uncertainly right now. But what is certain is that we live in some interesting times. Every day brings a new headline, and a lot of them are political. So far, the market has worked through it handsomely. Let’s hope our strong economic outlook continues to offset any ugliness coming out of the Barnum & Bailey Circus…err, I mean, Washington.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the Russell 2000 Index

**represented by the MSCI Emerging Markets Index

***represented by iShares Gold Trust

***represented by the ALPS Alerian MLP ETF