Why investors should cheer this bear market

Why investors should cheer this bear market

There is no doubt that 2022 has been a brutal year for investors. Many marquee household companies are down 30%, 40%, and 50%. Some have posted their worst performance in their history. The conservative bond investors didn’t have much to cheer about either. The Fed raised their interest rates from practically zero to 4.15%, which led to a drop in the value of most bond investments. For once in a lifetime, both equities and bonds fell simultaneously. Inflation reached a 40-year high.

2022 in the rearview mirror

The world witnessed the first European war and threats of using nuclear weapons since World War II.  And China imposed a zero covid lockdown that led Chinese citizens to be isolated in their homes for weeks and months. Adding to that the persistent covid outbreaks, RSV and monkeypox, $6 oil at the pump during the summer months, Hurricane Ian, the heatwave in California, and the polar vortex in Midwest.

And to add some entertainment to the public, the no longer richest person in the world decided to burn $44 billion on fire just because he could. Another young fellow in shorts and burly hair chose to use $3 billion in customer money to pursue his agenda and earn a comparison with Bernie Madoff. Let’s not forget that we had a mid-year election, and Democrats won the Senate, and the Republicans won the House. I am sure I am missing something.

So the regular folks like you and me could barely catch our breaths from one breaking news to the next in 2022. The journalist had a busy year. One could naturally wonder what 2023 has prepared for us.

Joe Biden, 80, and Trump, 76, declared they will run for president in 2024, as you know. I won’t comment on politics, but I expect the race to keep us glued to our smart devices and TVs through the election cycle.

Wall Street projections for 2023

Wall Street is also very divided in its projections. The S&P 500 ended the year at 3,839. The average estimate is for the index to finish at 4,031, with a huge gap between bulls and bears. The highest forecast is for 4,500, while the lowest reading is for $3,400. As a comparison, for 2022, the lowest forecast was for 4,400. So even the biggest bear got it wrong a big time.

Place your bets and throw the dice. If experts whose jobs are making market predictions can’t agree on where the market is heading, what about the average investor?

Despite all the gloom and doom that the media is trying to throw at us, there are a few things to cheer for in 2023. Let’s go through the list.

1. Earn interest on your cash savings.

After a decade of zero rates, you can finally earn a decent interest on your cash savings. You can easily earn 4% by buying a CD and over 3% in a high-yield online savings account. You have an excellent opportunity to build your emergency savings and earn a small return for keeping your money for a rainy day.

2. Better deals during a recession.

Most Wall Street economists are predicting a recession in 2023. Before you get too caught up in pessimism, I would like to cheer you up with the old Wall Street joke that economists have predicted the 9 of the past 5 recessions.

One thing I learned with great certainty in my forty-something years in this world is that it’s very hard to predict the future.

So whether the economists are right or wrong this time around remains to be seen. However, I clearly remember from the last two recessions in 2020 and 2008-2009 that some of the best deals occur during an economic slowdown. Retailers are clearing inventories at a deep discount. Contractors are willing to take smaller jobs. Family vacations get more affordable.

If you plan a home remodel or a big purchase, this might be your opportunity to lower your cost and negotiate your price.

3. Contribute more dollars to your 401k and Roth IRA.

I bet all devoted retirement savers love the news that 401k contribution limits went up by nearly 10% from $20,500 to $22,500. The catch-up contribution limit for employees over the age of 50 will increase to $7,500. The Roth IRA enthusiasts can save $6,500 in 2023, up from $6,000 in 2022.

4. You are getting a tax break.

Everything is going up these days. You have seen those price anomalies in your local restaurants and neighborhood supermarkets.

The good news is that tax brackets and standard deductions are also going up. Whether you got a promotion last year or your salary remained the same in 2023, you will catch a bit of a tax break.

For example, a married couple earning $250,000 in joint income and using the standard deduction will pay $40,152.00 in Federal Income taxes in 2023 vs. $41,455.00 in 2022.

5. Dollar-cost averaging

With the stock market down and a lot of uncertainty ahead, dollar-cost averaging is ideal for any remaining investors wanting to put new money in the market. I have previously discussed how timing the market can hurt your long-term financial goals. Dollar-cost averaging lets you have one foot in the water without jumping all in.

Dollar-cost averaging is a strategy that allows you to invest a specified amount of money periodically regardless of the market direction. Your bi-weekly 401k contributions are a perfect example of how dollar-cost averaging works. By participating in your employer 401k plan, you make consistent investments in the stock market every two weeks.

6. Lower valuations mean higher expected returns.

If I had offered a year ago to buy Amazon or Tesla shares at a 50% discount, would you have taken my offer? Some of you may have thought that I am crazy. I am sure a few people with an above-average risk tolerance would have taken it. But here we are. A long list of stocks has come down to Earth from sky-high valuations. For us, the investors, these lower prices mean only one thing – higher expected future returns.

Check out the chart below. The average 1-year return after a bear market bottom is nearly 50%. The annualized 5-year return is nearly 18%, and the 10-year return is 13.45%. For compassion, S&P 500 average annualized 20-year return is 9.80%

Stock market performance after bear market

As you can tell, as you get closer to the bottom of the bear market, the risk-reward potential becomes very attractive for both long-term investors and short-term traders. So those investors who are willing to weather the storm can reap the benefits in the future.

7. Stock picking is back.

Passive index investing underscored the last decade of investing after the end of the financial crisis. The mega-cap tech stock like Apple, Microsoft, Google, and Amazon dominated the S&P 500. The near-zero interest rate torpedoed the growth of smaller software and semiconductor firms with little to no earnings. The market wanted to pay for growth at any price until it didn’t.

We reached an inflection point that allows and forces us to evaluate each company individually based on its own merits. The new bull market wave will not take everyone with it this time. Firms that adapt quickly to new economic realities can succeed and reach their prior highs. Others will be left in the dust. New winners will be born.

8. Invest in yourself.

Your biggest asset is yourself. It’s not your house, job, car, or investment portfolio. It’s you.  Invest in yourself by:

  • building new relationships
  • learning new skills
  • getting a new job
  • improving your health
  • focusing on what makes you happy.

Manage your life the same way we manage your retirement portfolio by focusing on your long-term goals, diversifying your skills and connections, and remaining disciplined through lifecycles.

9. Live to fight another day.

You will agree that the last three years were not exactly a walk in the park.

  • 2020 was the year of covid and the great lockdown.
  • 2021 was the year of the great reopening and the supply chain disruption.
  • 2022 was the year of the great reset of expectations.

What will 2023 be? I will tell you for sure in 12 months, but I won’t mind if it’s a bit boring and uneventful.

So whether you are a bull or a bear, an optimist or a pessimist, an extrovert or an introvert, a wine aficionado or a foodie, be nice to yourself. Give yourself a big tap on the shoulder. You made it. Whatever 2023 ends ups being, make it the GREAT YEAR OF BEING YOU.

Bear market bottom and 10 sign to help you recognize it

Bear market bottom

A bear market bottom is often elusive and hard to identify. Every investor dreams of timing the stock market bottom and consistently buying low and selling high. But in reality, catching the bear market bottom is hard, even for experienced traders.

What is a bear market?

A bear market is a stock market correction of more than 20%. A stock or an index enters a bear market when the price drops by 20% or many from peak to trough. A bear market can be nerve-wracking as the stock market rarely goes down in a straight line. There are dramatic price movements in both directions while the general trend points lower.

What is a bear market bottom?

Bear market bottoms mark the end of the bear market and the start of a new bull market. While everyone wants to catch the exact moment, the bear market bottom is visible mainly in the rearview mirror.

Many investors emphasize a specific date when the stock market reaches an inflection point and bounces back to start a new bull market. However, the bear market bottoming is a process and may take several weeks or months before a meaningful rally occurs.

How to time the bear market bottom?

We generally do not advise trying to time the stock market. It’s a fool’s errand. You must be right twice in your investment process – when to cash out and when to get back in. Even if you time your exit correctly, you may be unable to time the bottom. You need to have a disciplined approach to getting back. You would go against the grain, and you would be buying while most people around you are panic selling.

Even though we don’t recommend it to everyone, timing the bear market bottom can help you invest extra cash sitting on the sideline or rebalance your portfolio.

Here are some signs that can help you recognize the bear market bottom either at present or in hindsight.

Peak negativity

There is no doubt that bear markets are bad news for the economy. 401k balances drop, forcing many people to delay their retirement. Some folks have to sell their investments because they lose their jobs or need extra cash. Media pundits go on TV to tell you that stocks are not a good investment and how far the stock market will go.

Companies lower their earnings expectations and announce hiring freezes and layoffs.

Stocks can lose 20% of their market value in a heartbeat. There is negative news everywhere.

The bear market will hit bottom before all the bad news has faded. Remember, the stock market is a leading indicator. It drops before an economic downturn and goes up ahead of an economic recovery.

Emotional capitulation indicates a bear market bottom

Bear markets can mess up your emotions. They are a true test of your risk tolerance and ability to absorb stock market volatility and losses.

The bear market bottom comes with emotional panic and the desire to sell everything. You may have heard of another term – market capitulation. That marks the time when the last bull has finally given up. Investors lose hope. Some people sell at the very bottom and never come back.

Cycle of market emotions and bear market bottom

The extreme negative emotions you may experience during a bear market, such as fear or depression, can leave you vulnerable to overstating the long-term risks of your investments. A few times during a bear market, people have asked me if the stock market is going down to zero.

In a bear market, your fears will magnify by the vivid stories of how bad things will get. You will hear a comparison with the Great Depression, the crash of 1987, the Great Financial Crisis, and the Covid meltdown. The strength of feeling could outweigh the power of the evidence. However, any of those events have been a point of maximum financial opportunity for investors.

Taking down the generals

The stock market will bottom only after causing significant pain to a maximum amount of stocks and market participants. The bear market will continue until it steamrolls all the generals and officers, aka the favored market leaders. Some old leaders may never return to the top, and a new cohort will take their place.

Here is the list of the top 10 stocks in the S&P 500 in 2008, just before the financial crisis –

ExxonMobile, Walmart, Microsoft, Procter  & Gamble, Johnson & Johnson, AT&T, JP Morgan, General Electric, Chevron, Pfizer.

Here is the list of the top 10 stocks in the S&P 500 as of November 1, 2022 – Apple, Microsoft, Amazon, Tesla, Alphabet, Berkshire Hathaway, United Health, Exxon Mobile, Johnson & Johnson, and JP Morgan

Insider Buying

Corporate executives and insiders receive most of their compensation in company stock and stock options. Their paycheck is a smaller portion of their total comp. The purpose of equity compensation is to align the interest of corporate executives with the shareholders. This system is not always perfect, but it serves its purpose.

There are many reasons insiders may want to sell their shares – paying off taxes, diversifying, and legacy planning. Many insiders have been notorious for selling at the top of their company stock price.

Take, for example, the CEO of ROKU, Anthony Wood. He has been consistently selling ROKU shares at various price points.

ROKU insider selling

Remember this signature insider buying when Jamie Dimon, the CEO of JP Morgan, bought 500,000 shares of the bank in the middle of the Global Financial Crisis. He made a 450% return on this purchase alone.

JPM insider buying at the bear market bottom

Regarding the overall stock market, I want to observe a broader insider buying from executives at various levels from companies across different industries and sectors. Corporate executives and board members have a closer view of their companies’ revenue and earnings projections. Meaningful insider buying activity will give us more confidence in the company’s prospects.

Broader insider buying signals a market bottom or a decisive inflection point. However, It’s essential to analyze insider buying in the context of the current macro environment, specific company news, and price action. Insiders are also human.

Increased M&A activities

During a bear market, many stocks are selling at a discount. Larger companies swoop in and swallow smaller competitors at favorable terms.

M&A activities can happen during all economic conditions. However, the combination of stocks down 20% or 30% and higher acquisition activities can indicate that CEOs feel confident about their companies and the strength of the economy.

Stocks go up on bad news.

Eventually, sellers get exhausted. And there is nobody left to sell. All remaining are long-term investors and true believers.

At that point in time, stocks could start going up even after bad news. Why you may ask. The stock market tends to overshoot both on the upside and the downside. All the bad news eventually gets priced in. So every new piece of bad news might be incrementally better news than the previous. There could be a result of various factors, such as margins remaining stable or earnings not being as bad as feared.

Consecutive UVOL days

Here is one technical indicator that frequently precedes the actual market bottom. And often, it gets missed.

UVOL is the percentage of stocks that go up on any given day. Research has shown that after a significant market decline, 2 or 3 consecutive days of UVOL above 90%, followed by at least 80% positive participation, will signal an inflection point. New buyers are stepping in and finding prices attractive.

For example, during the first three months of 2009, the stock market was down nearly 23% and 53% since January 1, 2008.

Consequitive UVOL days at the bear markrt bottom

As you can see, despite the market being down, we had multiple days when 90% or 80% of all stock was up on the same day. Ultimately, the S&P 500 hit bottom on March 6 and never looked back.

Fed policies become more accommodative.

The Federal Reserve is one of the leading players causing recession and bear markets. When the Fed wants to stimulate the economy, it lowers interest and increases its balance sheet to improve liquidity and boost overall economic conditions.

On the other hand, when the Fed wants to slow down the economy, they reduce their balance sheet and hike interest rates.

Why would they want to intervene in the market,  you may ask? The Fed has a dual mandate – full employment and price stability. If unemployment is too high, the Fed will lower rates to help corporations borrow money at a lower cost of capital and eventually hire more people.

When inflation goes above the Fed target rate, as in 2022, the 1970s, and the early 1980s, the Fed hikes the interest rates to slow down the economy and suppress demand.

Steepening yield curve

In a typical economic climate, long-term bonds and loans carry a higher interest than short-term bonds and loans. The premium compensates the lender for taking a bigger risk and waiting longer to receive their money back.

The spread between short-term and long-term rates is an indicator of the health of the economy. An inverted yield curve had preceded nearly all recessions in US history. This phenomenon occurs when short-term interest rates are higher than long-term interest rates.

I102YTYS_chart

An inverted yield curve is a warning sign that the economy will slow down and possibly fall into recession. Higher short-term rates indicate that structural factors are negatively affecting the economy.

When the Fed lowers short-term rates and the yield curve becomes positively sloped, it is usually a sign that economic conditions are improving and business is returning to usual. The timing of slope change doesn’t always coincide with the exact date of the market bottom. You must consider the impact in the context of the macro environment.

Stocks above 200-day moving averages

Remember, we said in the beginning that bottoming is a process. A stock could take 6 to 12 months or even longer to find its bottom and move up. One measure of price trajectory is the 200-day moving average indicator. As the name suggests, 200 DMA is the average stock price for the last 200 trading days. Taking the series of rolling 200-day moving averages should show the trajectory of the stock price. Stocks in a bear market will have a declining 200-DMA curve and will most likely trade below the 200-day curve for an extended period.

XOM 200-DMA

For stocks to complete the bottoming process, they need to shift the direction of the 200 DMA curve from downward to upward. Many traders and investors will wait for the specific stock or index to surpass the 200-day moving average level before buying back.

Stocks in a strong bull market will trade above their 200 DMA curve, serving as a support level.

Bear market bottom and the Fed

The bear markets are volatile. Trying to time the exact bottom is a nearly impossible task. Our emotions will most likely drive us to sell rather than buy at that moment. Also,  not every bear market is the same. All these signals that we discussed may not appear at the same time. Some may not appear at all, as every economic cycle is unique.

Investors have relied on the Fed for years to save the stock market from disseminating losses. The Fed doesn’t have the mandate to support the market. But in recent years, they have used the stock market to achieve their mission of full unemployment and low inflation. The Fed will only intervene in saving the market when it supports its agenda.

15 Costly retirement mistakes

15 Costly retirement mistakes

15 Costly retirement mistakes… Retirement is a major milestone for many Americans. Retiring marks the end of your working life and the beginning of a new chapter. As a financial advisor, my job is to help my clients avoid mistakes and retire with confidence and peace of mind.  Together we build a solid roadmap to retirement and a gameplan to achieve your financial goals. My role as a financial advisor is to provide an objective and comprehensive view of my clients’ finances.  As part of my process, I look for any blind spots that can put my clients’ plans at risk.  Here is a list of the major retirement mistakes and how to avoid them.

1. Not planning ahead for retirement

Not planning ahead for retirement can cost you a lot in the long run. Delaying to make key decisions is a huge retirement mistake that can jeopardize your financial security during retirement. Comprehensive financial planners are more likely to save for retirement and feel more confident about achieving their financial goals.  Studies have shown that only 32% of non-planners are likely to have enough saved for retirement versus 91% of comprehensive planners.

Reviewing your retirement plan periodically will help you address any warning signs in your retirement plan. Recent life changes, economic and market downturns or change in the tax law could all have a material impact on your retirement plans. Be proactive and will never get caught off guard.

2. Not asking the right questions

Another big retirement mistake is the fear of asking the right question. Avoiding these

Here are some of the questions that my clients are asking –

  • “Do I have enough savings to retire?”
  •  “Am I on the right track?”.
  • “Can I achieve my financial goals?”
  • “Can I retire if the stock market crashes?”.
  • “Are you fiduciary advisor working in my best interest?” (Yes, I am fiduciary)

Asking those tough questions will prepare you for a successful retirement journey. Addressing your concerns proactively will take you on the right track of meeting your priorities and achieving your personal goals

3. Not paying off debt

Paying off debt can be an enormous burden during retirement. High-interest rate loans can put a heavy toll on your finances and financial freedom. As your wages get replaced by pension and social security benefits, your expenses will remain the same. If you are still paying off loans, come up with a plan on how to lower your debt and interest cost. Being debt-free will reduce the stress out of losing viable income.

4. Not setting goals

Having goals is a way to visualize your ideal future. Not having goals is a retirement mistake that can jeopardize your financial independence during retirement. Without specific goals, your retirement planning could be much harder and painful. With specific goals, you have clarity of what you want and what you want to achieve. You can make financial decisions and choose investment products and services that align with your objectives and priorities. Setting goals will put you on a successful track to enjoy what matters most to you.

5. Not saving enough

An alarming 22% of Americans have less than $5,000 in retirement savings. The average 401k balance according to Fidelity is $103,700. These figures are scary. It means that most Americans are not financially ready for retirement. With ultra-low interest rates combined with constantly rising costs of health care,  future retirees will find it difficult to replace their working-age income once they retire. Fortunately, many employers now offer some type of workplace retirement savings plans such as 401k, 403b, 457, TSP or SEP IRA. If your employer doesn’t offer any of those, you can still save in Traditional IRA, Roth IRA, investment account or the old fashioned savings account.

6. Relying on one source for retirement income

Many future retirees are entirely dependent on a single source for their retirement income such as social security or pension.  Unfortunately. with social security running out of money and many pension plans shutting down or running a huge deficit, the burden will be on ourselves to provide reliable income during our retirement years.  If you want to be financially independent, make sure that your retirement income comes from multiple sources.

7. Lack of diversification

Diversification is the only free lunch you can get in investing and will help decrease the overall risk of your portfolio. Adding uncorrelated asset classes such as small-cap, international and emerging market stocks, bonds, and commodities will reduce the volatility of your investments without sacrificing much of the expected return in the long run.

A common mistake among retirees is the lack of diversification. Many of their investment portfolios are heavily invested in stocks, a target retirement fund or a single index fund.

Furthermore, owning too much of one stock or a fund can cause significant issues to your retirement savings. Just ask the folks who worked for Enron or Lehman Brothers who had their employer’s stocks in their retirement plans. Their lifetime savings were wiped out overnight when these companies filed for bankruptcy.

8. Not rebalancing your investment portfolio

Regular rebalancing ensures that your portfolio stays within your desired risk level. While tempting to keep a stock or an asset class that has been on the rise, not rebalancing to your original target allocation can significantly increase the risk of your investments.

9. Paying high fees

Paying high fees for mutual funds and high commission insurance products can eat up a lot of your return. It is crucial to invest in low-cost investment managers that can produce superior returns over time. If you own a fund that has consistently underperformed its benchmark,  maybe it’s time to revisit your options.

Many insurance products like annuities and life insurance while good on paper, come with high upfront commissions, high annual fees, and surrender charges and restrictions.  Before signing a contract or buying a product, make sure you are comfortable with what you are going to pay.

10. No budgeting

Adhering to a budget before and during retirement is critical for your confidence and financial success. When balancing your budget, you can live within your means and make well-informed and timed decisions. Having a budget will ensure that you can reach your financial goals.

11. No tax planning

Not planning your taxes can be a costly retirement mistake. Your pension and social security are taxable. So are your distributions from 401k and IRAs. Long-term investing will produce gains, and many of these gains will be taxable. As you grow our retirement saving the complexity of assets will increase. And therefore the tax impact of using your investment portfolio for retirement income can be substantial. Building a long-term strategy with a focus on taxes can optimize your after-tax returns when you manage your investments.

12. No estate planning

Many people want to leave some legacy behind them. Building a robust estate plan will make that happen. Whether you want to leave something to your children or grandchildren or make a large contribution to your favorite foundation, estate, and financial planning is important to secure your best interests and maximize the benefits for yourself and your beneficiaries.

13. Not having an exit planning

Sound exit planning is crucial for business owners. Often times entrepreneurs rely on selling their business to fund their retirement. Unlike liquid investments in stocks and bonds, corporations and real estate are a lot harder to divest.  Seling your business may have serious tax and legal consequences. Having a solid exit plan will ensure the smooth transition of ownership, business continuity, and optimized tax impact.

14. Not seeing the big picture

Between our family life, friends, personal interests, causes, job, real estate properties, retirement portfolio, insurance and so on, our lives become a web of interconnected relationships. Above all is you as the primary driver of your fortune. Any change of this structure can positively or adversely impact the other pieces. Putting all elements together and building a comprehensive picture of your financial life will help you manage these relationships in the best possible way.

15. Not getting help

Some people are very self-driven and do very well by planning for their own retirement. Others who are occupied with their career or family may not have the time or ability to deal with the complexities of financial planning. Seeking help from a fiduciary financial planner can help you avoid retirement mistakes. A fiduciary advisor will watch for your blind spots and help you find clarity when making crucial financial decisions.

Guide to the coronavirus economic fallout

Guide to the coronavirus economic fallout

Our guide to the coronavirus economic fallout. The world is facing the biggest health crisis in 100 years. The COVID-19 outbreak has infected over 2 million people worldwide and caused hundreds of thousands of lost lives. The unprecedented global lockdown and social distancing policies became an existential threat to travel, entertainment, retail, and service businesses. Many companies from large to small struggle to cover their basic costs and pay employees. Despite the government’s initial hopes for a quick recovery and fast rebound, the economic conditions remain uncertain.

Unemployment

In a matter of a few weeks, 22 million Americans have filed for unemployment. Corporations, universities, local governments, and non-profit organizations of all sizes are furloughing workers. Disney has furloughed 70,000 cast members. Best Buy announced plans to furlough about 51,000 employees The New York Metropolitan Opera has furloughed all its union employees—musicians, chorus members, stagehands, and other supporting staff.

"Survival

According to St. Louis Fed projections, the coronavirus economic freeze could cost 47 million jobs and send the unemployment rate past 32%. These figures are just staggering.

Fiscal Policy

In response to the coronavirus economic fallout, the Congress passed the Coronavirus Aid, Relief, and Economic Security Act of 2020. The CARES Act offered $2.2 trillion fiscal stimulus, intending to bring relief to families and businesses hit hardest by the impacts of the COVID-19 outbreak.

Support for Individuals and Families

  • The CARES acts offered one-time stimulus checks of $1,200 for individuals with AGI up to $75,000 or a head of household with AGI up to. $112,500. All joint filers, with AGI up to $150,000 are eligible for $2,400. Those amounts increase by $500 for every child
  • Eligible laid-off workers will get an extra $600 per week on top of their state benefit, until July 31.
  • The federal government has waived up to six months of payments and interest for many federal student loan borrowers. Until Sept. 30, there will be automatic payment suspensions for any student loan held by the federal government
  • Employers can pay up to $5,250 of student loans without that money counting as part of the employee’s income
  • Waiving penalties for withdrawing of as much as $100,000 from IRA, 401k and other retirement plans

Support for Small Businesses

  • The CARES Act provided $349 billion in partially forgivable SBA loans for small businesses with 500 or fewer employees to cover payroll and other expenses
  • 50% refundable retention tax credit for employers to encourage businesses to keep workers on their payroll
  • A delay in employer-side payroll taxes for Social Security until 2021 and 2022

Growing budget deficit

According to the Congressional Budget, the stimulus package designed to mitigate the economic damage brought by the novel coronavirus pandemic will add $1.76 trillion to federal budget deficits over the coming decade. The CBO estimates that the Federal spending will rise by $1.314 trillion in the 2020 to 2030 period as a result of the legislation, At the same time revenues are expected to fall by $446 billion.

"Survival

Monetary Policy

In response to the economic fallout, the Federal Reserve instituted a series of programs and measures to soften and battle the impact of the crisis. Among many things, the Fed dropped the Fed fund rate to zero. Furthermore, the Fed unleashed its crisis toolkit and restarted Quantitative Easing with the purchase of US treasuries and mortgage loans. The Fed has nearly unlimited power to buy repos, commercial papers, muni bonds, investment-grade bonds, bond ETFs and certain below-investment-grade bonds. The Fed also started a $600 billion lending facility to help businesses affected by the COVID-19 pandemic with up to 10,000 employees.

Unlike previous crises, the Fed acted proactively and rapidly in its efforts to dampen to negative effects of the sudden liquidity crisis. Its swift approach provided a financial lifeline to businesses and local governments. Despite the initial negative reactions, the Fed managed to reinstitute an order in the US bond market.

Survival guide to the coronavirus economic fallout

As a result of its efforts to combat the crisis, the Fed balance sheet has nearly doubled. The total share of Federal Reserve assets to GDP reached 28%. These levels were last seen since in the 1940s during the Gold standard.

US Federal Reserve asset as a shate of GDP

The stock market plunged and then bounced back

From February 20, 2020, to March 23, 2020, the S&P 500 lost nearly 34% of its value. Dow Jones Industrial fell -36%. The Nasdaq fared a little bit better at -29% loss. Russell 2000 dropped -40%.

Between March 23, 2020, till April 17, 2020, S&P 500 gained 28.5% with a total year to date loss of -11%. Nasdaq Composite was down -3% for 2020. Dow Jones Industrial Index lost -15%. While Russell 2000 was significantly lower at -26% for the year.

Major Srock indices performance
Major Srock indices performance between January 1 and April 17, 2020.

The most important driver for this rapid rebound was the Federal Reserve’s massive monetary stimulus plan, combined with the $2.2 trillion rescue package of the U.S. government. These unprecedented measures sent a confidence signal that the US is willing to take any step to save the economy.

Flight to quality and strong balance sheet

Amid initial fears and intense sell-off investors have moved to mega-cap companies with a strong balance sheet and core revenues that can weather the storm.

Some of the big winners of the coronavirus crisis are companies that directly benefit from a prolonged stay-at-home economy, a growing number of working from home business models, as well as pharma companies developing drugs and vaccines against the COVID-19 virus. The travel, retail, financial and energy companies were the hardest hit with many of them losing between 50% to 80% of their market value.

 

The Stock market and the Economy send conflicting messages

According to the Wall Street Journal – “The Dow Jones Industrial Average staged its best two-week performance since the 1930s, a dramatic rebound that has left many investors with a confounding reality: soaring share prices and a floundering economy.

The explosive rally is a sign that many are positioning for the U.S. to make a speedy recovery when the coronavirus crisis eases. Investors have been encouraged in recent days by signs that several states will move to resume business, along with hopes that a viable treatment for COVID-19 could be near.”

According to JP Morgan – “The Fed’s latest move reinforces our view of a full asset price recovery, and equity markets reaching all-time highs next year. Investors with [a] focus on negative upcoming earnings and economic developments are effectively ‘fighting the Fed,’ which was historically a losing proposition.”

Despite these positive views, this stock market rebound comes on the heels of growing unemployment, dropping retail sales, and Fed’s projections of US GDP falling by 5% in 2020.

We are in unchartered territory

  • There is no playbook to combat this health crisis.
  • The US economy was growing at a steady 2% a year with record-low unemployment. Restarting the economy at full speed may take several years
  • China’s GDP shrank by 6.8% in the first quarter of 2020 giving us a glimpse of what to expect.
  • Pre-crisis, many US workers had inadequate retirement savings and insufficient rainy-day money. There is many Americans living paycheck to paycheck.
  • The small businesses which have always been the foundation of the US economy are facing an existential threat for survival. Many family-owned companies relying on higher volume sales and small margins may never be able to compete with large firms.
  • The SBA $349 billion Paycheck Protection Program was depleted in less than 2 weeks.
  • While many pharmaceutical companies are working on a COVID-19 vaccine, we do not expect the vaccine to be widely available until 2021. Some of the trial drugs that have shown positive treatment results will not be a solution for this crisis.
  • We need rapid tests widely available to hospitals, businesses, airports, public venues, and schools. Some types of social distancing measures will continue through the end of 2020 and potentially 2021.

How to manage your investments and savings

We have very little control over the stock market and the economy. But we have full control of our actions.

During this crisis, focus on what you can control.

Set your financial goals and have a plan

Having a solid financial plan will help you ensure that you are following of your long-term financial goals and staying on track. The investment performance of your portfolio is a key component of your future financial success but it’s not the most important factor. Be disciplined, patient and consistent in following your long-term goals while putting emotions aside

If you do not have a financial plan, this a perfect time to start one. A holistic financial will help you create a comprehensive view of your personal and financial life and have a clear understanding of the main risks and abilities to achieve financial independence and confidence.

Keep cash

As a financial advisor, I always recommend keeping an emergency fund worth at least 6 to 12 months of your living expenses. An emergency fund will allow you to build a cushion and survive a prolonged economic uncertainty. Furthermore, it will prevent you from dipping into your retirement savings which could significantly deteriorate your financial health in the future. The best time to build your rainy-day fund is when the economy is strong and healthy.

Know your investment horizon

Your investment horizon is a product of your financial goals. It will determine the level of investment risk you should be taking. If you are retiring soon and need your investments for retirement income, then your investment horizon is short. Short investment horizon in general means a lower level of risk. If you are young and do not need your retirement savings and investments for a few years and decades, then your investment horizon is long. In this case, you can afford to take on more risk.

Assess your risk tolerance

Risk tolerance is a measure of our emotional ability to accept market volatility. It is not so simple to quantify people’s emotions with numbers. As humans, we are always more likely to be risk-averse during market turbulence and more risk-tolerant when the stock market is going higher. If you are willing to accept short-term losses for potential long-term gains, then your risk tolerance is high. If you are not willing to accept any losses, then your risk tolerance is very low.

Review your investment portfolio

Tune-up your investments regularly. You should review your investment portfolio in connection with your financial plan, investment horizon, and risk tolerance. Make sure that your investments support your financial goals and needs.

Keep your 401k

One of the biggest mistakes you could possibly make now is to drop and stop contributing to your 401k plan. Many people gave up on their retirement savings during the financial crisis and never restarted them. As a result, we have a generation of people with no retirement savings. As a 401k participant, you make regular monthly or semi-monthly payments to your plan. You benefit from dollar-cost averaging and buying stocks at lower prices during market volatility.

Take time to self-reflect and reconnect

Social distancing and stay-at-home lifestyle can emotionally burdensome and isolating. In these times, it is important to stay connected with friends and family. This is a great opportunity to learn new skills, reassess your priorities, and catch up on house projects. For those who like to travel, the economic slowdown is a paradise for travel deals.

Final words

If you have any questions about your investments and how to navigate through these turbulent times, feel free to reach out. if you are worried about finances I am here to listen and help.

The Coronavirus and your money

Coronavirus and your money

The Coronavirus and your money.  After an unprecedented 10% rally, which started in October of 2019, the stock market is finally hitting a rough patch. The quick spread of the coronavirus in China and around the world made investors nervous about the future of the global economy. The 2% pullback on January 31 wiped out most of January gains. Despite the quick recovery in early February, the outbreak of the virus in South Korea, Japan, Iran, and Italy triggered a massive sell-off on Monday, February 24. The major US indices dropped 3.5% in one day, with DOW falling over 1,000 points.
Investors seeking safety pushed the price of Gold to $1,650. The 10-year treasury rate fell to 1.34, and the 30-year treasury bonds now pay 1.85%. The price of crude oil fell to $51 per share.

About the virus

The coronavirus, called COVID-19, started in the city of Wuhan in the Chinese province of Hubei. Until now, there were over 80,000 reported cases in China and around the world and nearly 2,700 fatalities. The virus spread came on the heels of Chinese Lunar Year celebrations, which is a primary holiday and travel period. It is estimated that Chinese travelers make 3 billion trips in the 40 days surrounding this major Chinese holiday. Currently, more than 60 million people have been locked down in China alone.
The governments around the world have limited or directly banned travelers coming from China. Many foreign businesses like Apple, IKEA, Disney, and Starbucks have shut down stores and theme parks.

The impact on Wuhan

Wuhan is a major transportation and industrial hub in China. More than 300 of the world’s top companies have a presence in Wuhan, including Microsoft, German-based software company SAP, and carmakers General Motors, Honda, and Groupe PSA.
The total value of trade imports and exports in Wuhan reached $35.3 billion in 2019, a record high that was 13.7% above the previous year.

The Bear case

A continued outbreak of the coronavirus can shave off between 0.5% to 1% of the already slowing Chinese GDP. As the second-biggest economy, China is one of the largest importers of commodities and materials.
An extended lockdown will hurt sales of all foreign companies doing business in China. It can trickle down to the already fragile economies of the EU,  Japan, and other export-oriented countries.
The lockdown in China will hurt the global supply chain and the limit the manufacturing abilities of companies making their products in China.
The virus outbreak in Italy, South Korea, and Iran creates a lot of uncertainty and puts pressure on local authorities to control the further spread out.
The previous virus threats (Ebola, SARS, Zika) hurt travel-related businesses and took several months before the markets fully recovered.

The Bull case

The US economy remains strong. The unemployment rate is at record low levels of 3.5%. Low-interest rates and low gasoline prices will support further growth in consumer spending and housing sales.
While not completely sheltered, the US economy is less dependent on exports to China.
The Fed has more room to cut rates if the US economy experiences a slowdown as a result of the virus.
The Chinese government is introducing a new monetary and fiscal stimulus package to support the economy.
Slowing GDP will make the Chinese government more willing to sign the Phase 2 trade deal with the US.
Pharma companies (reportedly Gilead and Moderna) are pursuing a virus vaccine.
Spring is coming. The warm weather could limit the impact of the virus around the world.

Your investments

  • Keep the course. Have a long-term view and focus on achieving your financial goals.
  • Market volatility is a normal part of the investment cycle.
  • S&P 500 index pays a 1.8% dividend versus a 1.3% yield for the 10-year treasury. A long-term income investors may find it compelling to invest in dividend-paying stocks over bonds.
  • A significant stock pullback will be an opportunity to buy high-quality US companies.
  • If you are looking for a specific action, check out my recent article on how to cope with market downturns:  https://www.babylonwealth.com/survive-market-downturn/

Market Outlook October 2019

market Outlook October 2019

Highlights:

  • S&P 500 recorded a modest gain of 0.9% in the third quarter of 2019
  • Ten-year treasury rate dropped to 1.5% before bouncing back to 1.75%
  • S&P 500 dividend yield is now higher than the 20-year treasury rate
  • Manufacturing index hits contraction territory

Economic Overview

  • The US economy continues to show resiliency despite increased political uncertainty and lower business confidence
  • The consumer sentiment – The US consumer is going strong. Consumer sentiment reached 93 in September 2019. While below record levels, sentiment remains above historical levels. Consumer spending, which makes up 68% of the US GDP, continues to be the primary driver of the economy.
Market Outlook October 2019 Consumer Sentiment
Consumer Sentiment
  • Unemployment hits 3.5%, the lowest level since 1969
  • Wage growth of 2.9% remains above-target inflation levels
  • Household debt to GDP continues to trend down and is now at 76%.
Market Outlook October 2019
Household debt to GDP
  • Fed rate cuts – Fed announced two rate cuts and is expected to cut twice until the end of the year.
  • The 10-year treasury rate is near 1.75%
  • The 30-year mortgage rate is near 3.75%
  • While low-interest rates and low unemployment continue to lift consumer confidence, the question now is, “Can the US consumer save the economy from recession’?
  • The probability of recession is getting higher. Some economists assign a 25% chance of recession by the end of 2020 or 2021.
  • The ISM Manufacturing index dropped to 47 in September, falling under for a second consecutive month. Typically readings under 50 show a sign of contraction and reading over 50 points to expansion. The ISM index is a gauge for business confidence and shows the willingness of corporate managers to higher more employees, buy new equipment and reinvest in their business.
  • Trade war – What started as tariff threats in 2018 have turned into a full-blown trade war with China and the European Union. The Trump administration announced a series of new import tariffs for goods coming from China and the EU. China responded with yuan devaluation and more tariffs. France introduced a new digital tax that is expected to impact primary US tech giants operating in the EU.
  • A study by IHS Markit’s Macroeconomic Advisers calculated that gross domestic product could be boosted by roughly 0.5% if uncertainty over trade policy ultimately dissipates.
  • Chinese FX and Gold reserves – China’s reserve assets dropped by $17.0b in September, comprising of $14.7bn drop in FX reserves and a $2.4bn decline in the gold reserves. China has been adding to its gold reserves for ten straight months since December 2018.
  • Political uncertainty – Impeachment inquiry and upcoming elections have dominated the news lately. Fears of political gridlock and uncertainty are elevating the risk for US businesses.
  • Slowing global growth – The last few recessions were all domestically driven due to asset bubbles and high-interest rates. This time could be different, and I do not say that very often. Just two years ago, we saw a consolidated global growth with countries around the world reporting high GDP numbers. This year we witness a sharp turn and a consolidated global slowdown. EU economies are on the verge of recession. The only thing that supports the Eurozone is the negative interest rates instituted by the ECB. China reported the slowest GDP growth in decades and announced a package of fiscal spending combined with tax cuts, regulatory rollbacks, and targeted monetary easing geared to offset the effect of the trade war and lower consumer spending. So even though the US economy is stable, a prolonged slowdown of global economies could drag the US down as well.

Equities

US Equities had a volatile summer. Most indices are trading close to or below early July levels and only helped by dividends to reach a positive quarterly return. On July 27, 2019, S&P 500 closed at an all-time high of 3,025, followed by an August selloff. A mid-September rally helped S&P 500 pass 3,000 level again, followed by another selloff. S&P 500 keeps hovering near all-time highs despite increased volatility, with 3,000 remaining a distinct level of resistance.

In a small boost for equities, the dividend yield on the S&P 500 is now higher than the 10- and 20- year US Treasury rate and barely below the 30-year rate of 2%.

For many income investors equities become an alternative to generate extra income over safer instruments such as bonds

Market Outlook October 2019
S&P 500 dividend versus 20-year treasury rate

Growth versus Value

Investing in stocks with lower valuations such as price to earnings and price to book ratios has been a losing strategy in the past decade. Investors have favored tech companies with strong revenue growth often at the expense of achieving profits. They gave many of those companies a pass in exchange for a promise to become profitable in the future.

However, while economic uncertainty is going up, the investors’ appetite for risk is going down. The value trade made a big comeback over the summer as investors flee to safe stocks with higher dividends. As a result, the utilities and consumer staple companies have outperformed the tech sector.

The IPO market

The IPO market is an indicator of the strength of the economy and the risk appetite of investors. In 2019, we had multiple flagship companies going public. Unfortunately, many of them became victims of this transition to safety. Amongst the companies with lower post IPO prices are Uber, Lyft, Smiles Direct Club, and Chewy.com. Their shares were down between -25% and -36% since their inception date. Investors walked away from many of these names looking for a clear path to profitability while moving to safety stocks.

Market Outlook October 2019, Uber and Lyft since IPO

Small-Cap

Small caps have trailed large caps due to increased fears of recession and higher market volatility. Small caps tend to outperform in a risk-on environment, where investors have a positive outlook on the economy.

Market Outlook October 2019, Small Cap versus Large Cap

International Stocks

International stocks continue to underperform. On a relative basis, these stocks are better valued and provide a higher dividend than US stocks. Unfortunately, with a few exceptions, most foreign stocks have been hurt by sluggish domestic and international demand and a slowdown in manufacturing due to higher tariffs. Many international economies are much more dependent on exports than the US economy.

Fixed Income

The Fed continued its accommodative policy and lowered its fund rate twice over the summer. Simultaneously, other Central Banks around the world have been cutting their rates very aggressively.

The European Central Bank went as far as lowering its short-term funding rate to -0.50%. As a result, the 30-year German bund is now yielding -0.03%. The value of debt with negative yield reached $13 trillion worldwide including distressed issuers such as Greece, Italy, and Spain.

Investors who buy negative-yielding bonds are effectively lending the government free money.

In one of my posts earlier in 2019, I laid out the dangers of low and negative interest rates. You can read the full article here. In summary, ultra-low and negative interest rates change dramatically the landscape for investors looking to supplement their income by buying government bonds. Those investors need to take more risk in their search for income. Low rates could also encourage frivolous spending by politicians and often lead to asset bubbles.

The Yield Curve

The yield curve shows what interest rate an investor will earn at various maturities. Traditionally, longer maturities require a higher interest rate as there is more risk to the creditor for getting the principal back. The case when long-term rates are lower than short-term rates is called yield inversion. Some economists believe that a yield inversion precedes a recession. However, there is an active debate about whether the difference between 10y and 2y or 10y and 3m is a more accurate indicator.

Market Outlook October 2019, Yield Curve

As you can see from the chart, the yield curve gradually inverted throughout the year. Short-term bonds with 3-month to maturity are now paying higher interest than the 10-year treasury

Credit spreads

The spread between AAA investment-grade and lower-rated high yield bonds is another indicator of an imminent credit crunch and possible economic slowdown.

Market Outlook October 2019, Credit Spreads

Fortunately, corporate rates have been declining alongside treasury rates. Spreads between AAA and BBB-rated investment grade and B-rated high yield bonds have remained steady.

Repo market crisis

The repo market is where banks and money-market funds typically lend each other cash for periods as short as one night in exchange for safe collateral such as Treasuries. The repo rates surged as high as 10% in mid-September from about 2.25% amid an unexpected shortage of available cash in the financial system. For the first time in more than a decade, the Federal Reserve injected cash into the money market to pull down interest rates.

The Fed claimed that the cash shortage was due to technical factors. However, many economists link the shortages of funds as a result of the central bank’s decision to shrink the size of its securities holdings in recent years. The Fed reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system.

Gold

Gold has been a bright spot in our portfolio in 2019. After several years of dormant performance, investors are switching to Gold as protection from market volatility and low-interest rates. In early September, the precious metal was up nearly 21% YTD, but since then, retracted a bit.

Market Outlook October 2019, Gold

Gold traditionally has a very low correlation to both Equities and Bonds. Even though it doesn’t generate income, it serves as an effective addition to a well-diversified portfolio.

The Gold will move higher if we continue to experience high market volatility and uncertainty on the trade war.

Final words

The US economy remains resilient with low unemployment, steadily growing wages, and strong consumer confidence. However, few cracks are starting to appear on the surface. Many manufacturers are taking a more cautious position as the effects of the global slowdown and tariffs are starting to trickle back to the US. An inverted yield curve and crunch in the repo market have raised additional concerns about the strength of the economy.

Despite the media’s prolonged crisis call, we can avoid a recession. The recent trade agreement between the US and Japan could open the gate for other bilateral trade agreements. Given that the US elections are around the corner, I believe that this administration has a high incentive to seal trade agreements with China and the EU.

The market is expecting two more Fed cuts for a total of 0.5% by the end of the year. If this happens, the Fed fund rate will drop to 1.25% – 1.5%, possibly flattening or even steepening the yield curve, which will be a positive sign for the markets.

Those with mortgage loans paying over 4% in interest may wish to consider refinancing at a lower rate.

Market volatility is inevitable. Keep a long-term view and maintain a well-diversified portfolio.

The end of the year is an excellent time to review your retirement and investment portfolio, rebalance and take advantage of any tax-loss harvesting opportunities.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is the founder of Babylon Wealth Management and a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning and investment management for growing families, physicians, and successful business owners.

 

If you have any questions about the markets and your investments, reach out to me at [email protected] or +1-925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

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Market Outlook July 2019

Market Outlook July 2019

Breaking records

So far 2019 has been the year of breaking records. We are officially in the longest economic expansion, which started in June of 2009. After the steep market selloff in December, the major US indices have recovered their losses and reached new highs. The hopes for a resolution on trade, the Fed lowering interest rates and strong US consumer spending, have lifted the markets.  At the same time, many investors remain nervous fearing an upcoming recession and slowing global growth.

S&P 500 in record territory

S&P 500 hit an all-time high in June, which turned out to be best June since 1938. Furthermore, the US Large Cap Index had its best first quarter (January thru March) and the best first half of the year since the 1980s.

S&P 500 Performance since January 2018
Market Outlook July 2019

US treasuries rates declined

Despite the enthusiasm in the equity world, fixed income investors are ringing the alarm bell. 10-year treasury rate dropped under 2%, while 2-year treasuries fell as low as 1.7%.

10-year Treasury versus 2-year treasury and 3-month treasury.

We continue to observe a persistent yield inversion with the 3-month treasury rates higher than 2-year and 10-year rates. Simultaneously, the spread between the 2 and 10-year remains positive. Historically, a yield inversion has been a sign for an upcoming recession. However, most economists believe that the 2-10-year spread is a better indicator than the 3m-10-year spread.

Gold is on the move

Gold passed 1,400. With increased market volatility and investors fears for a recession, Gold has made a small comeback and reached $1,400, the highest level since 2014.

Bonds beating S&P 500

Despite the record highs, S&P 500 has underperformed the Bond market and Gold from October 2018 to June 2019 S&P 500 is up only 1.8% since October 1, 2018, while the 10-year bond rose 8.7% and Gold gained 16.8%. For those loyal believers of diversification like myself, these figures show that diversification still works.

S&P 500 versus 10-year treasury and Gold

Defensive Stocks lead the rally in Q2

Consumer Staples and Utilities outperformed the broader market in Q2 of 2019. The combination of lower interest rates, higher market volatility and fears for recessions, have led many investors into a defensive mode. Consumer staples like Procter & Gamble and Clorox together with utility giants like Southern and Con Edison have led the rally in the past three months.

Utilities and Consumer Staples performance versus S&P 500.

Small-Cap lagging

Small cap stocks are still under all-time high levels in August of 2018. While both S&P 600 and Russell 2000 recovered from the market selloff in December o 2018, they are still below their record high levels by -13.6% and 10% respectively

S&P 600 and Russell 2000 9-month performance.

International Stocks disappoint

International Developed and Emerging Stocks have also not recovered from their record highs in January of 2018.  The FTSE International Developed market index is 13.4% below its highest levels. While MSCI EM index dropped nearly 18.3% from these levels.

International stocks performance

The Fed

After hiking their target rates four times in 2018, the Fed has taken a more dovish position and opened the door for a possible rate cut in 2020 if not sooner. Currently, the market is expecting a 50-bps to a 75-bps rate cut by the end of the year.

As I wrote this article, The Fed chairman Jerome Powell testified in front of congress that crosscurrents from weaker global economy and trade tensions are dampening the U.S. economic outlook. He also said inflation continues to run below the Fed’s 2% target, adding: “There is a risk that weak inflation will be even more persistent than we currently anticipate.”

Unemployment

The unemployment rate remains at a record low level at 3.7%. In June, the US economy added 224,000 new jobs and 335,000 people entered the workforce. The wage growth was 3.1%.

Consumer spending

The US consumer confidence remains high at 98 albeit below the record levels in 2018. Consumer spending has reached $13 trillion. Combined with low unemployment, the consumer spending will be a strong force in supporting the current economic expansion.

Manufacturing is weakening

The Institute for Supply Management (ISM) reported that its manufacturing index dropped to 51.7 in June from 52.1 in May. Readings above 50 indicate activity indicate expanding, while those below 50 show contraction. While we still in the expansion territory, June 2019 had the lowest value since 2016. Trade tensions with China, Mexico, and Europe, and slowing global growth have triggered the alarm as many businesses are preparing for a slowdown by delaying capital investment and large inventory purchases.  

Trade war truce for now

The trade war is on pause. After a break in May, the US and China will continue their trade negotiations. European auto tariffs are on hold. And raising tariffs on Mexican goods is no longer on the table (for now). Cheering investors have lifted the markets in June hoping for a long-term resolution.

Dividend is the king

With interest rates remaining low, I expect dividend stocks to attract more investors’ interest. Except for consumer staples and utilities, dividend stocks have trailed the S&P 500 so far this year. Many of the dividend payers like AT&T, AbbVie, Chevron, and IBM had a lagging performance. However, the investor’s appetite for income could reverse this trend.

The 3,000

As I was writing this article the S&P 500 crossed the magical 3,000. If the index is able to maintain this level, we could have a possible catalyst for another leg up of this bull market.

The elections are coming

The US Presidential elections are coming.  Health Care cost, rising student debt, income inequality, looming retirement crisis, illegal immigration, and the skyrocketing budget deficit will be among the main topics of discussion. Historically there were only four times during an election year when the stock market crashed. All of them coincided with major economic crises – The Great Depression, World War II, the bubble, and the Financial crisis.  Only one time, 1940 was a reelection year.

S&P 500 Returns During Election Years

YearReturnCandidates
192843.60%Hoover vs. Smith
1932-8.20%Roosevelt vs. Hoover
193633.90%Roosevelt vs. Landon
1940-9.80%Roosevelt vs. Willkie
194419.70%Roosevelt vs. Dewey
19485.50%Truman vs. Dewey
195218.40%Eisenhower vs. Stevenson
19566.60%Eisenhower vs. Stevenson
19600.50%Kennedy vs. Nixon
196416.50%Johnson vs. Goldwater
196811.10%Nixon vs. Humphrey
197219.00%Nixon vs. McGovern
197623.80%Carter vs. Ford
198032.40%Reagan vs. Carter
19846.30%Reagan vs. Mondale
198816.80%Bush vs. Dukakis
19927.60%Clinton vs. Bush
199623.00%Clinton vs. Dole
2000-9.10%Bush vs. Gore
200410.90%Bush vs. Kerry
2008-37.00%Obama vs. McCain
201216.00%Obama vs. Romney
201611.90%Trump vs. Clinton

Final words

The US Economy remains strong despite headwinds from trade tensions and slowing global growth. GDP growth above 3% combined with a possible rate cut lat and resolution of the trade negotiations with China, could lift the equity markets another 5% to 10%.

Another market pullback is possible but I would see it as a buying opportunity if the economy remains strong.

If your portfolio has extra cash, this could be a good opportunity to buy short-term CDs at above 2% rate.

Reach out

If you have any questions about the markets and your investment portfolio, reach out to me at [email protected] or +925-448-9880.

You can also visit my Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

Market Outlook April 2019

Market Outlook April 2019

In my last commentary in early January, right after the December vortex, I gave 30% chance that the bull market will recover and 50% chance that we will see more volatility in the upcoming six months.  My view of the economy was still positive. And I didn’t see reasons for a recession at that time. I was somewhat right and wrong. My market outlook remains cautiously positive. Let’s break it down.

Equity markets

The markets were a little bit choppy at the beginning of January and the end of March. But overall all major equity markets in the US and abroad posted impressive quarterly performance. In fact, it was the S&P 500’s best quarter in decades. The S&P 500 index rose by 13% in the first three months of the year. Russell 2000 added 14.3%. The international stocks grew by about 10%.

Major markets' performance between January 2018 and Match 2019.

However, to put that in perspective, the S&P 500 is still a few percentage points below its all-time high in September of 2018. At the same time, Small caps are nearly 13% below its highest mark. While International Developed and Emerging Market stocks have been in a steep decline since their highs in January of 2018 and haven’t even come close to these levels.

So, I was wrong because, despite a few volatile trading days, the market remained relatively calm. The Q1 standard deviation was well below the 10-year average. After the Fed chair Jerome Powell stated that the Fed would be more cautious in raising interest rates in 2019 after their initial forecast of three rate hikes, the market took a leap of faith.

The US and international markets continue to diverge. The chart above shows the difference in performance between these two markets.

Growth versus value

Another interesting story is the growing gap between Growth and Value stocks. Value stocks have done pretty much nothing in the past 15 months while growth stocks have been a power horse.

Equity markets show a gap between Growth versus value stocks .

The trade wars

We also got mixed but mostly positive news from the US-China trade negotiations. The investors want the deal, and both sides seem motivated to strike one. The truth is that the US is the biggest market for Chinese export and China is the biggest market for US tech and industrial giants.  However, a lot of the issues with intellectual property and copyright protection, government subsidies and influence on corporate boards, privacy concerns, limited market access to China for US companies and so on, have accumulated for decades. But It will take more than a handshake to get these issues resolved.

Fixed Income Markets

The fixed-income traders have probably seen better days. For the first time in over a decade, the 10-year treasury rate is lower than the 3-month treasury rates. The maturity premium is now negative. This type of rate tightness is known as an inverted yield curve. The yield inversion has historically preceded all economic recessions. But not all inverted yield curves have led to a recession.

Fixed Income Markets are in turmoil. Comparing 3-month, 2-year and 10-year treasury rates.

This second chart below shows the gap between the Fed and Wall Street on their view of the world. The Fed who can only influence the short-end of the curve by its lending window has pushed the short-term rates by nearly 39% in the past 12 months. Those of us with saving accounts are finally seeing decent rates after ten years of drought.

Change in 3-month, 2-year and 10-year rates between January 2018 and Match 2019.

However, the long end of the curve, which is primarily determined by market supply and demand has declined by almost 12%

Soft landing or recession

The fixed income markets are waiving the red flag while the equity market remains positive. Somebody must be wrong.

Negative signals

I see a mixed bag of both positive and negative signals. On one side, US and Chinese economies continue to grow steady though with a slower pace. US Q4 GDP growth was 2.4% down from 3.4% in the third quarter of 2018. The Chinese economy expanded 6.6 percent in 2018, which is the weakest pace since 1990.

Furthermore, according to FactSet, the S&P 500 EPS estimate dropped by 7.2% (to $37.33 from $40.21) during Q1 of 2019. The decline in EPS was larger than the 5-year average (3.2%), the 10-year (3.7%), and the 15-year average (4%) cut. Additionally, payroll slowdown below forecast in the third quarter, hitting an 18-month low in March.

On the other track, Germany posted only 0.6% YoY GDP growth in 2018 with a nearly zero growth in the Q4 of 2018. Japan reported a 0.3% annual growth, after contracting -0.6% in Q3 of 2018.  Earlier in March ECB’s Mario Draghi said that there had been a “sizable moderation in economic expansion that will extend into the current year.” The ECB lowered its growth forecast for 2019 from 1.7% to 1.1%. Furthermore, the ECB halted its plans to hike rates and introduced another round of financing for European banks.

Positive signals

On the positive side, new home sales posted the highest gain in February after a steep decline in the second half of 2018. The US unemployment rate remains low at 3.8%. The US consumer sentiment went up to 98.4 in March 2019 after diving in January. The Chinese PMI surpassed economists’ estimates. New orders climbed to their highest level in four months, while the index for new export orders returned to expansionary territory.

The big question remains if the US will follow the EU and Japan into a recession/stagnation mode. Or the Fed and the Trump administration will maneuver the economy into a soft landing with slower but still healthy earnings growth, high consumer sentiment and robust business spending.

What to expect

Predicting the markets could be a treacherous task. Even successful economists sometimes make wrong conclusions. Humbly, I thought that the UK and the EU will figure out a soft Brexit, while the outcome is still hanging up in the air. I also thought that the economy would not slow down so quickly, but the combination of volatile oil prices, high interest rates, and trade war rhetoric really moved the needle in the wrong direction.  The next three to six months will be crucial to see if we are indeed heading into a slowdown or the economy is just taking a deep breath before going into another growth spurt.

The first quarter market recovery created an opportunity to take some risk off the table and rebalance your portfolio to your original risk tolerance targets.

What to watch

I am going to watch the performance of Growth versus Value stocks. In a world of slowing global economy, companies with a wide moat, high earnings growth, and big margins will continue to drive the markets. Separately, the flat yield curve and interest rates could boost interest in higher dividend paying stocks.

Also, I am going to watch the yield curve for significant moves in either direction. With short-term rates effectively higher than 10-year treasuries, for those sitting on extra cash, it might be tempting to get into one of those high-interest CDs. Currently, a 1-year CD is paying anywhere between 2.65% and 2.85%.

Contact Us

If you’d like to discuss how the market impacts your investments, please feel free to reach out and learn more about our fee-only financial advisory and OCIO services. We will meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.

Stoyan Panayotov, CFA 
Founder | Babylon Wealth Management

CFA Charterholder. Everything yu need to know about the markets. Let's build a better world for investing.
Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is the sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

Market Outlook 2019

2019 Market Outlook

Happy New Year to all!

2018 kept us on our toes. It seems that 2019 is promising to do the same.

All major world indices posted declines in 2018. S&P 500 finished lower by -4.5%. While the small-cap S&P 600 was down-8.5%. The International MSCI EAFE closed -13.8% cheaper for the year. The Bloomberg Aggregate Bond Index finished 2018 barely positive with most gains generated in the last quarter as most investors moved to Treasuries as a result of the increased volatility in the equity markets. Gold also ended in negative territory despite the 7.5% gain in the last quarter.

Major indices in 2018

Index Q1 2018 Q2 2018 Q3 2018 Q4 2018 FY 2018
S&P 500 Large-Cap (SPY) -1.00% 3.55% 7.65% -13.52% -4.56%
S&P 600 Small-Cap (IJR) 0.57% 8.69% 4.87% -20.18% -8.49%
MSCI EAFE (EFA) -0.90% -1.96% 1.52% -12.62% -13.81%
Barclays US Aggregate Bond (AGG) -1.47% -0.18% -0.08% 1.85% 0.10%
Gold (GLD) 1.73% -5.68% -4.96% 7.53% -1.94%

Source: Morningstar

We will remember 2018 with the return of volatility. Investors enjoyed relatively calm markets in 2017, which had only 8 trading days when the S&P 500 moved more than 1% in either direction, 5 down and 3 up days. For comparison, 2018 had 65 trading days when the index moved more than 1%, split evenly between positive and negative days. Overall 2018 had more positive trading days 131 versus 119. However, the average positive session was +0.69% versus the average negative session of -0.81%.

CBOE Volatility Index (^VIX) – 2017-2018

2019 Market Outlook. CBOE Volatility Index (^VIX) – 2017-2018
Source: Yahoo Finance

So, what led to this outcome. Unlike other bear markets, no single catalyst that caused this market selloff. But there was a combination of factors that formed a perfect storm and pushed the markets over the edge. In my previous post from November and December 2018, I talked about a list of these factors. Let me go over some of the most important ones.

Corporate buybacks

A big contributor to the positive returns earlier in the year was the companies’ share buybacks. After TCJA reduced the corporate tax rate to 21%, many corporations found themselves with extra cash, which they used to buyback their own stock. After the lockout period in October and the first spikes in volatility, the buybacks declined significantly.

High valuations

After a 9-year bull market and a record low-interest environment, equity valuations reached levels not seen since the tech bubble. The S&P 500 was trading at P/E of 24.9 in the early January of 2018, away above the average level of 15.7. Even after the market sell-off S&P 500 is trading around 19 P/E.

Furthermore, the Shiller PE Ratio reached 33.3, one of the highest levels in history. After the market correction, the ratio stands at 27, away above the average of 16.5.

While the traditional Price to Earnings ratio is calculated based on current or estimated earnings levels, the Schiller ratio calculates average inflation-adjusted earnings from the previous ten years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio) or PE10.

Price of Oil

After reaching $74.15 per barrel in October, US crude oil tumbled to $43, a 42% drop. While lower crude prices are pushing down on inflation, they are hurting energy stocks, which barely recovered from the previous fall in oil prices. Furthermore, the oil’s rapid decline is fueling fears for global oversupply and slowing economic growth.

The Fed’s continued hiking of interest rates in the US was not coordinated with its counterparts in the ECB, the UK, and Japan. Currently the US 10-year treasury yields 2.58%. At the same time, the German 10-year bund now yields 0.15%, while Japanese 10-year government bond went back in the negative territory of -0.01%. Combining the higher US rates with failing = Brexit talks, Italian budget crisis, and negative trade war outcome has led to a strong US dollar reaching a 17-month high versus other major currencies.

Strong dollar

Given that 40% of S&P 500 companies’ revenue comes from foreign countries, the strong dollar is making Americans goods and services more expensive and less competitive abroad. Furthermore, US companies generating earnings in foreign currency will report lower US-dollar denominated numbers.

Slowing global growth

The market decline in the last three months of 2018 came in the backdrop of strong corporate earnings and record high consumer optimism. Overall, the S&P 500 members reported record earnings in the Q3 of 2018. 78% of them have reported better than expected actual earnings with an average earnings growth rate of 25.2%.

On the other side, a growing number of companies in the S&P 500 (58 or 12%) have issued negative earnings guidance for Q4 2018 and beyond. Most recently Apple reported lower revenue guidance as a result of weak demand in China and lower than expected iPhone replacement in the US.

Corporate CFOs are starting to take a more defensive approach. Business investment grew only at a 0.8% annual rate in the third quarter, down from 8.7% in the second quarter. This was the slowest pace since the fourth quarter of 2016.

The investment bank Nomura also came out with the forecast expecting global growth to slow down. Their economists predicted that global growth in 2019 would hit 3.7% and temper to 3.5% in 2020 from 3.9% in 2018. According to Nomura, the drivers for the slowdown include waning fiscal stimulus in the U.S., tighter monetary policy from the Federal Reserve, increased supply constraints and elevated risk of a partial government shutdown.

Trade War

The impact of President Trump’s trade war is finally became obvious. With many US businesses relying on revenue from China and the EU, one company after another are starting to warn for lower revenue guidance in 2019.

The latest global PMI (Purchasing Managers Index) survey shows a slowdown in global production growth. According to JP Morgan and HIS Markit Survey: “The global manufacturing sector continued to register a subdued performance at the close of 2018. Output growth remained weak, while rates of expansion in new orders and employment both slowed. The trend in international trade flows also remained weak, with new export business declining for the fourth straight month. The JP Morgan Global Manufacturing PMI™ fell to a 27-month low of 51.5 in December, down from 52.0 in November. The average reading over the fourth quarter (51.8) was the lowest since quarter three of 2016.”

The housing market is slowing down

Both existing and new home sales have come down this year.  Rising interest rates, higher cost of materials, labor shortage and high real estate prices in major urban areas have led to a housing market slow down.  Existing home sales dropped 3.4% in September coming down for six months in a row this year. New building permits are down 5.5% over 2017.

The investors have taken a negative view of the housing market. As a result, most homebuilders, home improvement retailers, and lumber producers are trading at 52-week lows.

Consumer debt is at a record high

The US consumer debt is reaching 4 trillion dollars. Consumer debt includes non-mortgage debts such as credit cards, personal loans, auto loans, and student loans. Student loans are equal to $1.5 trillion while auto debt is $1.1 trillion and credit card debt is close to $1.05 trillion. Furthermore, the US housing dent also hit a record high. In June, the combined mortgage and home equity debt were equal to $9.43 trillion, according to the NY Fed. So far, the rising consumer debt has been supported by low delinquencies, higher property values, rising wages, and low unemployment. However, a slowdown in the economy paired with higher interest rates can putt his equilibrium at risk.

High Yield and BBB-rated debt is growing

The size of the US corporate debt market has reached $7.5 trillion. The size of the BBB rated debt, which is just one notch above junk status, now exceeds 50% of the entire investment grade market.

Bloomberg pointed out that, in 2000, when BBB bonds were only a third of the market, the corporate net leverage (total debt minus cash and short-term investments divided by earnings before interest, taxes, depreciation, and amortization) was 1.7 times. By the end of last year, the ratio had ballooned to 2.9 times.

Further on, the bond powerhouse PIMCO commented: “This suggests a greater tolerance from the credit rating agencies for higher leverage, which in turn warrants extra caution when investing in lower-rated IG names, especially in sectors where earnings are more closely tied to the business cycle.”

Interest rates

Interest rates were the hot topic of 2018 and will continue to be in 2019. With government debt passing $21 trillion and record high consumer and corporate, it is not a surprise that the market is very jittery to rising interest rates. The Fed hiked its overnight lending rate four times in 2018, to 2.25% – 2.50% level. Subsequently, the 10-year Treasury reached 3.24%, before falling to 2.58% as of January 3rd, 2019. In the meantime, the rates of the 2- and 5-year treasuries started to converge in what is known as inverted yield curve.

2019 Market Outlook. Convergence of interest 10-year, 5-year and 2-year rates  over the last 5 years
Convergence of interest 10-year, 5-year and 2-year rates over the last 5 years

2019 Outlook

The US Economy remains strong despite headwinds from multiple directions. Major macroeconomic factors are in positive territory.

  • Highest corporate earnings growth since 2010, over 25% over the first 3 quarters of 2018
  • The last quarter of S&P 500 EPS growth is expected to be between 12% and 15%
  • Equity valuations reach fair territory after the recent selloff.
  • GDP growth over 3%
  • Record high consumer sentiment
  • End of year holiday shopping is expected to beat all records
  • Record low unemployment
  • Highest wage growth since 2008
  • Business activity remains high
  • Interest rates remain under historical levels
  • Low oil prices will temper inflation and lower business cost

Many economists believe that we are in the last leg of economic expansion. And, some are even predicting a market recession in 2020. However, historically economists and equity have not been an accurate indicator for economic recessions. Realistically speaking it would be very hard to enter an economic downturn from where we are today unless we see a very steep deterioration of government policies and business and consumer spending.

Obviously, at this stage, it is hard to predict the equity markets in 2019. I am looking at three major scenarios, which all have realistic chances of developing.

Scenario 1 (30%)

The bull market continues. The US and China reach a mutually beneficial trade agreement. China commits to relax the rules of US firms conducting business in China and strengthen rules for parent protections. The Fed is more cautious about raising interest rates. Apple’s earnings are not as bad as the market is anticipating. Lower interest rates and oil prices help businesses manage their costs, offset slow down in housing sales and boost consumer spending. The corporate earnings growth beats analyst forecast across the board.

Scenario 2 (20%)

We could see another 10-20% decline in Global Stocks before reaching a bottom. Trump continues to criticize the Fed and interfere in its independence. The government shutdown and political bipartisanship continues without a long-term solution. The Brexit is a disaster. China and the US do not reach a meaningful trade agreement that satisfies the markets. Companies continue to report lower revenue and earnings guidance, and some may start laying off employees.  

Scenario 3 (50%)

Global stocks remain volatile for the first 6 months of the year with major swings in both directions. The equity market becomes extremely sensitive to both positive and negative news.

For long-term investors

The best investment strategy has always been buy-and-hold. Trying to time the market is a bad idea. There are many studies that show timing the market has underperformed a buy and hold strategy in the long run. For example, a long-term investor who bought SPY (SPDR S&P 500 ETF) on January 2nd, 2008 would have more than doubled her investment and achieve a 7.2% total return (price appreciations plus dividends).

If you are uncertain about the markets and achieving your financial goals, seek advice from a fiduciary advisor who has your best interest in mind.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized investment management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

The December market meltdown explained

S&P 500 is down almost -16% so far in the last quarter of 2018. The market rout which started in October continued with a powerful selloff in December. The technology-heavy NASDAQ is down -20%, while the small-cap Russell 2000 dropped nearly -22%.

Despite our strong economy major buyers remain on the sideline and retail investors are looking for a bottom..

In my previous article, I talked about the perfect storm that started the market drop in October. Since then more negative news continued to bombard the markets. The markets do not like uncertainty.

Here are some of the factors that triggered fears across the sellers.

  1. Apple stopping to report iPhone sales
  2. FedEx reporting lower guidance for 2019
  3. The resignation of General Mattis
  4. Government shutdown
  5. Failing Brexit negotiations
  6. Trump criticizing the Fed
  7. The recent arrest of Huawei CFO and three Canadians in China
  8. The price of oil dropping to $43.
  9. Yield curve inversion
  10. Growin fears for an upcoming recession
  11. The dominance of electronic and algorithm trading
  12. Low trading volumes due to the holiday season

The combination of more negative news and low trading volumes created yet another perfect storm for what we observed in December 2018.

The asset classes performance

2018 will remain in history as the year when holding cash was the only profitable strategy.  Almost all major asset classes are in the red for 2018.

Future Outlook

As I mentioned earlier, all major macroeconomic factors are in a positive territory.

  • Highest corporate earnings growth since 2010
  • GDP growth over 3%
  • Record high consumer sentiment
  • End of year holiday shopping is expected to beat all records
  • Record low unemployment
  • Highest wage growth since 2008
  • Business activity remains high
  • Interest rates stay under historical levels
  • Low oil prices will temper inflation and business cost

Many economists believe that we are in the last leg of economic expansion. Moreover, some are even predicting a market recession in 2020. However, there is an old joke that the markets have predicted 9 out of the past 5 recessions. In spite the fact that equity markets are forward-looking, they have not been an accurate indicator for an economic recession.

Realistically speaking it would be very hard to enter recession from where we are today unless we see a very steep deterioration in 2019.

The law of mean reversion.

Everything reverts to the mean sooner or later. Last year we had one of the least volatile markets in our recent history. As a result, the S&P 500 standard deviation, a measure of risk, dropped to 3.8% well below average historical levels of 13%. This year’s market volatility is back to these average levels.

Diversify

In any market environment, volatile or not, diversification is essential way to reduce portfolio risk.

Think long term

The best long-term investment strategy has always been buy-and-hold. Trying to time the market is a bad idea. There are many studies that show timing the market would underperform a buy and hold strategy in the long run.

Don’t watch the market every day.

Media skews the news to what is trendy and get more readership.

Use your best judgement.

Panicking has never helped anyone. If you are uncertain seek advice from a fiduciary advisor who has your best interest in mind. 

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

The recent market volatility – the tale of the perfect storm

The recent market volatility – the tale of the perfect storm

The recent market volatility – the tale of the perfect storm

October is traditionally a rough month for stocks. And October 2018 proved it.

S&P 500 went down -6.9% in October after gaining as much as 10.37% in the first nine months of the year. Despite recouping some of its losses in early November, the market continues to be volatile, with large daily swings in both directions. On top of that, Small Cap stocks, which were leading the way till late September, went down almost 10% in the span of a few weeks.

So, what led to this rout?

The market outlook in September was very positive. Consumer sentiment and business optimism were at a record high. Unemployment hit a record low. And the market didn’t really worry about tariffs.

I compiled a list of factors that had a meaningful impact on the recent market volatility. As the headline suggested, I don’t believe there was a single catalyst that drove the market down but a sequence of events creating a perfect storm for the equities to go down.

Index Q1 2018 Q2 2018 Q3 2018 Q3 YTD 2018 Oct – Nov 2018 Nov 2018 YTD
S&P 500 Large-Cap (SPY) -1.00% 3.55% 7.65% 10.37% -4.91% 5.45%
S&P 600 Small-Cap (IJR) 0.57% 8.69% 4.87% 14.64% -9.54% 5.09%
MSCI EAFE (VEA) -0.90% -1.96% 1.23% -1.62% -7.06% -8.68%
Barclays US Aggregate Bond (AGG) -1.47% -0.18% -0.08% -1.73% -0.81% -2.54%
Gold (GLD) 1.73% -5.68% -4.96% -8.81% 1.39% -7.42%
Source: Morningstar

1. Share buybacks

The month of October is earnings season. Companies are not allowed to buy back shares as they announce their earnings. The rationale is that they possess significant insider information that could influence the market in each direction. As it turned out, 2018 was a big year for share buybacks. Earlier in the year, S&P estimated $1 trillion worth of share buybacks to be returned to shareholders. So, in October, the market lost a big buyer – the companies who were buying their own shares. And no one stepped in to take their place.

The explosion of share buyback was prompted by the TCJA law last year which lowered the tax rate of US companies from 35% to 21%. Additionally, the new law imposed a one-time tax on pre-2018 profits of foreign affiliates at rates of 15.5% for cash and 8% for non-cash assets. Within a few months, many US mega-cap corporations brought billions of cash from overseas and became buyers of their stock.

2. High valuations

With the bull market is going on its ninth year, equity valuations remain high even after the October market selloff.

Currently, the S&P 500 is trading at 22.2, above the average level of 15.7. Its dividend yield is 1.9%, well below the historical average of 4.34%.

Furthermore, the current Shiller PE Ratio stands at 30.73, one of the highest levels in history. While the traditional Price to Earnings ratio is calculated based on current or estimated earning levels, the Schiller ratio calculates average inflation-adjusted earnings from the previous ten years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio) or PE10.

While a coordinated global growth and low-interest rate environment had previously supported the thesis that high valuation ratios were justified, this may not be the case for much longer.

3. The divergence between US and international stocks

The performance of International Developed and Emerging Market remains disappointing. While the US markets are still in positive territory, International Developed and EM stocks have plunged by -8% and -15% respectively so far in 2018.  Higher tariffs imposed by the US, negative Brexit news, growing domestic debt in China, and slower GDP growth in both the Eurozone and China have spurred fears of an upcoming recession. Despite attractive valuations, international markets remain in correction territory, The dividend yield of MSCI EAFE is 3.34%, while MSCI EM is paying 2.5%, both higher than 1.9% for S&P 500.

4. The gap between growth and value stocks

The performance gap between growth and value stocks is still huge. Growths stocks like Apple, Amazon, Google, Visa, MasterCard, UnitedHealth, Boeing, Nvidia, Adobe, Salesforce, and Netflix have delivered 10% return so far this year. At the same time value strategies dominated by Financials, Consumer Staples and Energy companies are barely breaking even.

Index Q1 2018 Q2 2018 Q3 2018 Q3 YTD 2018 Oct – Nov 2018 Nov 2018 YTD  P/E Ratio
S&P 500 Large Cap Growth (IVW) 1.81% 5.17% 9.25% 16.97% -6.95% 10.01% 29.90
S&P 500 Large Cap Value (IVE) -3.53% 1.38% 5.80% 3.26% -2.59% 0.67% 19.44

 

5. Tempering earnings growth

So far in Q3 2018, 90% of the companies have announced earnings. 78% of them have reported better than expected actual earnings with an average earnings growth rate of 25.2%. 61% of the companies have reported a positive sales surprise. However, 58 companies in the S&P 500 (12%) have issued negative earnings guidance for Q4 2018. And the list of stocks that tumbled due to cautious outlook keeps growing – JP Morgan, Facebook, Home Depot, Sysco, DR Horton, United Rentals, Texas Instruments, Carvana, Zillow, Shake Shack, Skyworks Solutions, Michael Kors, Oracle, GE, Cerner, Activision, etc.

Despite the high consumer optimism and growing earnings, most companies’ CFOs are taking a defensive approach. Business investment grew at a 0.8% annual rate in the third quarter, down from 8.7% in the second quarter. This was the slowest pace since the fourth quarter of 2016.

The investment bank Nomura also came out with the forecast expecting global growth to slow down. Their economists predicted that global growth in 2019 would hit 3.7% and temper to 3.5% in 2020 from 3.9% in 2018. According to Nomura, the drivers for the slowdown include waning fiscal stimulus in the U.S., tighter monetary policy from the Federal Reserve, increased supply constraints and elevated risk of a partial government shutdown.

 

6. Inflation is creeping up

Almost a decade since the Credit Crisis in 2008-2009, inflation has been hovering below 2%. However, in 2018, the inflation has finally made a comeback. In September 2018, monthly inflation was 2.3% down from 2.9% in July and 2.7% in August.

One winner of the higher prices is the consumer staples like Procter & Gamble, Unilever, and Kimberly-Clark. Most of these companies took advantage of higher consumer confidence and rising wages to pass the cost of higher commodity prices to their customers.

7. Higher interests are starting to bite

After years of near-zero levels, interest rates are starting to go higher. 10-year treasury rate reached 3.2%, while the 2-year rate is slowly approaching the 3% level. While savers are finally beginning to receive a decent interest on their cash, CDs and saving accounts, higher interest rates will hurt other areas of the economy.

 

With household debt approaching $13.4 trillion, borrowers will pay higher interest for home, auto and student loans and credit card debt. At the same time, US government debt is approaching $1.4 trillion. Soon, the US government will pay more for interest than it is spending on the military.  The total annual interest payment will hit $390 billion next year, nearly 50 percent more than in 2017, according to the Congressional Budget Office.

The higher interest rates are hurting the Financial sectors. Most big banks have enjoyed a long period of paying almost nothing on their client deposits and savings accounts. The rising interest rates though have increased the competition from smaller banks and online competitors offering attractive rates to their customers.

We are also monitoring the spread between 2 and 10-year treasury note, which is coming very close together. The scenario when two-year interest rates go above ten-year rates causes an inverted yield curve, which has often signaled an upcoming recession.

8. The housing market is slowing down

Both existing and new home sales have come down this year.  Rising interest rates, higher cost of materials, labor shortage and high real estate prices in major urban areas have led to a housing market slow down.  Existing home sales dropped 3.4% in September coming down for six months in a row this year. New building permits are down 5.5% over 2017.

Markets have taken a negative view on the housing market. As a result, most homebuilders are trading at a 52-week low.

9. Fear of trade war

Some 33% of the public companies have mentioned tariffs in their earnings announcements in Q3.  9% of them have negatively mentioned tariffs. According to the chart below, Industrials, Information Technology, Consumer Dictionary, and Materials are the leading sectors showing some level of concern about tariffs.

10. Strong dollar

Fed’s hiking of interest rates in the US has not been matched by its counterparts in the Eurozone, the UK, and Japan. The German 10-year bund now yields 0.4%, while Japanese 10-year government bond pays 0.11%. Combining the higher rates with negative Brexit talks, Italian budget crisis and trade war fears have led to a strong US dollar reaching a 17-month high versus other major currencies.

Given that 40% of S&P 500 companies’ revenue comes from foreign countries, the strong dollar is making Americans goods and services more expensive and less competitive abroad. Furthermore, US companies generating earnings in foreign currency will report lower US-dollar denominated numbers.

11. Consumer debt is at a record high

The US consumer debt is reaching 4 trillion dollars. Consumer debt includes non-mortgage debts such as credit cards, personal loans, auto loans, and student loans. Student loans are equal to $1.5 trillion while auto debt is $1.1 trillion and credit card debt is close to $1.05 trillion. Furthermore, the US housing dent also hit a record high. In June, the combined mortgage and home equity debt were equal to $9.43 trillion, according to the NY Fed.

The rising debt has been supported by low delinquencies, high property values, rising wages, and low unemployment. However, a slowdown in the economy and the increasing inflation and interest rates can hurt US consumer spending.

12. High Yield and BBB-rated debt is growing

The size of the US corporate debt market has reached $7.5 trillion. The size of the BBB rated debt now exceeds 50% of the entire investment grade market. The BBB-rated debt is just one notch above junk status. Bloomberg explains that, in 2000, when BBB bonds were a mere third of the market, net leverage (total debt minus cash and short-term investments divided by earnings before interest, taxes, depreciation, and amortization) was 1.7 times. By the end of last year, the ratio had ballooned to 2.9 times.

Further on, the bond powerhouse PIMCO commented: “This suggests a greater tolerance from the credit rating agencies for higher leverage, which in turn warrants extra caution when investing in lower-rated IG names, especially in sectors where earnings are more closely tied to the business cycle.”

13. Oil remains volatile

After reaching $74.15 per barrel in October, US crude oil tumbled to $55, a 24% drop. While lower crude prices are pushing down on inflation, they are hurting energy companies, which are already trading in value territory.

According to WSJ, the oil’s rapid decline is fueling fears for global oversupply and slowing economic growth. Furthermore, the outlook for supply and demand shifted last month as top oil producers, began ramping up output to offset the expected drop in Iranian exports. However, earlier this month Washington decided to soften its sanctions on Iran and grant waivers to some buyers of Iranian crude—driving oil prices down. Another factor pushing down on oil was the strong dollar.

14. Global political uncertainty

The Brexit negotiations, Italian budget crisis, Trump’s threats to pull out of WTO, the EU immigrant crisis, higher tariffs, new elections in Brazil, Malaysian corruption scandal and alleged Saudi Arabia killing of a journalist have kept the global markets on their toes. Foreign markets have underperformed the US since the beginning of the year with no sign of hope coming soon.

15. The US Election results

A lot has been said about the US elections results, so I will not dig in further. In the next two year, we will have a divided Congress. The Democrats will control the house, while the Republicans will control the Senate and the executive branch. The initial market reaction was positive. Most investors are predicting a gridlock with no major legislature until 2020. Furthermore, we could have intense budget negotiations and even another government shutdown. Few potential areas where parties could try to work together are infrastructure and healthcare. However, any bi-partisan efforts might be clouded by the upcoming presidential elections and Mueller investigation results.

In Conclusion

There is never a right time to get in the market, start investing and saving for retirement. While market volatility will continue to prevail the news, there is also an opportunity for diligent investors to capitalize on their long-term view and patience. For these investors, it is essential to diversify and rebalance your portfolio.

In the near term, consumer confidence in the economy remains strong. Rising wages and low unemployment will drive consumer spending. My prediction is that we will see a record high shopping season. Many of these fifteen headwinds will remain. Some will soften while others will stay in the headlines.

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at [email protected] or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

Market Outlook October 2018

Overview

The US stock market was on an absolute tear this summer. S&P 500 went up by 7.65% and completed its best 3rd quarter since 2013. Despite the February correction, the US stocks managed to recover from the 10% drop. All major indices reached a series of record highs at the end of August and September.

Index Q1 2018 Q2 2018 Q3 2018 YTD 2018
S&P 500 Large-Cap (SPY) -1.00% 3.55% 7.65% 10.37%
S&P 600 Small-Cap (IJR) 0.57% 8.69% 4.87% 14.64%
MSCI EAFE (VEA) -0.90% -1.96% 1.23% -1.62%
Barclays US Aggregate Bond (AGG) -1.47% -0.18% -0.08% -1.73%
Gold (GLD) 1.73% -5.68% -4.96% -8.81%
Source: Morningstar

 

The US Economy remains strong

Markets have largely shrugged off the trade war fears benefiting from a strong economy and high corporate earnings.

US Unemployment remains low at 3.9% in July and August, levels not seen since the late 1960s and 2000.

Consumer sentiment is at a multi-year high. The University of Michigan Consumer Sentiment Index hit 100.1 in September, passing 100 for the third time since the January of 2004.

Business optimism hit another record high in August.  The National Federation of Independent Business’ small business optimism index reached the highest level in the survey’s 45-year history. According to NFIB, small business owners are planning to hire more workers, raise compensation for current employees, add inventory, and spend more on capital investments.

A hypothetical 60/40 portfolio

A hypothetical 60/40 index portfolio consisting of 30% US Large Cap Stocks, 10% US Small Cap Stocks, 20% International Stocks, 33% US Fixed Income and 7% Gold would have returned 3.06% by the end of September.

Index Allocation Return
S&P 500 30% 3.11%
S&P 600 10% 1.46%
MSCI EAFE 20% -0.32%
Barclays USAgg Bond 33% -0.57%
Gold 7% -0.62%
Hypothetical Performance 3.06%

 

US Equity

I expect a strong Q4 of 2018 with a record high holiday consumer and business spending. While stock valuations remain elevated, robust revenue and consumer demand will continue to drive economic growth.

After lagging large-cap stocks in 2017, small-cap stocks are having a comeback in 2018. Many domestically focused publicly traded businesses benefited massively from the recent corporate tax cuts, higher taxes on imported goods and healthy domestic demand.

This year’s rally was primarily driven by Technology, Healthcare and Consumer Discretionary stocks, up 20.8%, 16.7%, and 13.7% respectively. However, other sectors like Materials, Real Estate, Consumer Staples, Financials and Utilities are either flat or negative for the year. Keep in mind of the recent reshuffle in the sector classification where Google, Facebook, Netflix and Twitter along with the old telecommunication stocks were added to a new sector called Communication services.

Sector performance

Sector Performance Price per Price to Dividend
YTD Earnings Sales Yield
as of 10/3/2018 (TTM)  (TTM) (%)
Communication Services -1.91% 22.6x 1.3x 4.83%
Consumer Discretionary 13.72% 16.5x 1.0x 1.27%
Consumer Staples -5.50% 15.1x 1.0x 2.86%
Energy 8.67% 14.0x 1.2x 1.74%
Financials 0.29% 15.2x 2.1x 1.91%
Health Care 16.71% 18.2x 1.2x 1.86%
Industrials 4.73% 15.7x 1.1x 1.85%
Information Technology 20.86% 14.8x 2.1x 0.90%
Materials -3.56% 13.2x 1.1x 1.79%
Utilities 0.77% 17.1x 1.3x 3.70%
Source: Bloomberg

 

I believe that we are in the last few innings of the longest bull market. However, a wide range of sectors and companies that have largely remained on the sidelines. Some of them could potentially benefit from the continued economic growth and low tax rates.

International Equity

The performance gap between US and foreign stocks continues to grow. After a negative Q1 and Q2, foreign stocks recouped some of the losses in Q3. Furthermore, emerging market stocks are down close to -9% for the year.

Bad economic data coming from Turkey, Italy, Argentina, Brazil, Indonesia, South Africa, and China along with trade war fears put downward pressure on foreign equity markets. Additionally, rising right-wing sentiments in Italy, Austria, Sweden, Hungary, and even Germany puts doubts on the stability of the European Union and its pro-immigration policies.

In my view, the risk that the financial crisis in Turkey, Argentina, and Italy will spread to other countries is somewhat limited. However, the short-term headwinds remain, and we will continue to monitor these markets.

Brexit

Another major headline for European stocks is the progress of the Brexit negotiation. While soft Brexit would benefit both sides, a hard exit could have a higher negative impact on the UK.

I remain cautiously positive on international stocks. According to WSJ, foreign stocks are trading at a 12% discount over US equity on price to earnings basis. This year created value opportunities in several counters. However, the issue with European and Japanese stocks is not so much in valuations but the search for growth catalysts in conservative economies with an aging population.

Fixed Income

Rising Fed rates and higher inflation have driven bond prices lower so far this year. With inflation rate hovering at 2%, strong employment figures, rising commodity cost, and robust GDP growth, the Fed will continue to hike interest rates. I am expecting one more rate hike in December and three additional hikes in 2019.

I will also continue to monitor the spread between 2-year and 10-year treasury. This spread is currently at 0.23%, the lowest level since 2005.  Normally, a negative spread, i..e 2-year treasury rare higher than 10-year is a sign of a troubled economy.

While modest, individual pockets of the fixed-income market are generating positive performance this year. For instance, short duration fixed income products are now yielding in the range of 1.5% to 2%. The higher interest is now a compelling reason for many investors to keep some of their holdings in cash, CDs or short-term instruments.

With 10-year treasury closing above 3% and moving higher, fixed income investors will continue to see soft returns on their portfolio.

Gold

Gold is one of the big market losers this year. The strong dollar and robust US economy have led to the precious metal sell-off.  While the rise cryptocurrency might have reduced some of the popularity of Gold, I still believe that a small position in Gold can offer a buffer and reduce the overall long-term portfolio volatility. The investors tend to shift to Gold during times of uncertainty.

Navigating market highs

With S&P 500, NASDAQ and Dow Jones hitting all-time highs, how should investors manage their portfolio?

Rebalance

End of the year is an excellent opportunity for reconciliation and rebalancing to your target asset allocation. S&P 500 has returned 16.65% in the past five years, and the chance that equities are taking a big chunk of your portfolio is very high. Realizing some long-term gains and reinvesting your proceeds into other asset classes will ensure that your portfolio is reset to your desired risk tolerance level as well as adequately diversified.

Think long-term

In late January and early February, we experienced a market sell-offs while S&P 500 dropped more than 10%. Investors in the index who did not panic and sold at the bottom recouped their losses and ended up with 10% return as of September 30, 2018. Taking a long-term view will help you avoid the stress during market downturns and allow you to have a durable long-term strategy

 

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at [email protected] or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

Market Outlook April 2018

Market Outlook April 2018

Market Outlook April 2018

After a record high 2017, the volatility has finally returned. Last year the market experienced one of the highest risk-adjusted performances in recent history. In 2017 there were only 10 trading where the S&P 500 moved by more than 1% in either direction, with not a single trading day when it moved by more than 2%. In contrast, in the 61 trading days of Q1 of 2018, we had 26 days when the S&P 500 moved by more than 1% and 8 days where it changed by more than 2%.

Learn more about our Private Wealth Management services

 

VIX Index Q1 2018

Market Outlook April 2018
VIX index Q1 2018. Source Yahoo Finance

The VIX Index, which measures the volatility of the S&P 500 started the year ar 9.77. It peaked at 37.33 and ended the quarter at 19.97.

Markets do not like uncertainty, and so far, Q1 had plenty of that. In the first 3 months of the year market landscape was dominated by news about rising inflation and higher interest rates, the Toys R Us bankruptcy, trade war talks and tariffs against China, and scandals related to Facebook user data privacy.

Except for Gold, all major market indices finished in the negative territory.

Index Q1 2018
S&P 500 -1.00%
Russell 2000 -0.18%
MSCI EAFE -0.90%
Barclays US Aggregate Bond Index -1.47%
Gold +1.73%

 

Fixed Income

Traditionally bonds have served as an anchor for equity markets. Over time stocks and US Treasury bond have shown a negative correlation. Usually, bonds would rise when stocks prices are falling as investors are moving to safer investments. However, in 2018 we observed a weakening of this relationship. There were numerous trading days when stocks and bonds were moving in the same direction.

On the other hand, despite rising interest rates, we see the lowest 10-year/2-year treasury spread since the October of 2007. The spread between the two treasury maturities was 0.47 as of March 29, 2018. While not definite, historically negative or flat spreads have preceded an economic recession.

Momentum

Momentum remained one of the most successful strategies of 2018 and reported +2.97%. Currently, this strategy is dominated by Technology, Financials, Industrials, and Consumer Cyclical stocks. Some of the big names include Microsoft, JP Morgan, Amazon, Intel, Bank of America, Boeing, CISCO, and Mastercard.

Value

Value stocks continued to disappoint and reported -3.73% return in the Q1 of 2018. Some of the biggest names in this strategy like Exxon Mobile, Wells Fargo, AT&T, Chevron, Verizon, Citigroup, Johnson & Johnson, DowDuPont and Wall-Mart fell close to or more than -10%. As many of these companies are high dividend payers, rising interest rates have decreased the interest of income-seeking investors in this segment of the market.

Small Cap

As small-cap stocks stayed on the sideline of the last year’s market rally, they were mostly unaffected by the recent market volatility.  Given that most small-cap stocks derive their revenue domestically, we expect them to benefit significantly from the lower tax rates and intensified trade war concerns.

Gold

Gold remained a solid investment choice in the Q1 of 2018. It was one of the few asset classes that reported modest gains. If the market continues to b volatile, we anticipate more upside potential for Gold.

 

Outlook

  • We anticipate that the market volatility will continue in the second quarter until many of the above issues get some level of clarification or resolution.
  • We expect that small and large-cap stocks with a strong domestic focus to benefit from the trade tariffs tension with China and other international partners
  • The actual impact of lower taxes on corporate earnings will be revealed in the second half of 2018 as Q3 and Q4 earnings will provide a clear picture of earnings net of accounting and tax adjustments.
  • Strong corporate earnings and revenue growth have the ability to decrease the current market volatility. However, weaker than expected earnings can have a dramatically opposite effect and drive down the already unstable markets.
  • If the Fed continues to hike their short-term lending rates and inflation rises permanently above 2%, we could see a further decline in bond prices.
  • Our strategy is to remain diversified across asset classes and focus on long-term risk-adjusted performance

 

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at [email protected] or +925-448-9880.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

 

Biggest Risks for the Markets in 2018

Biggest Risks for the Markets in 2018

Biggest Risks for the Markets in 2018

Wall Street is gearing for another record year on the equity market. On January 2nd Nasdaq crossed 7,000. A day later S&P 500 reached 2,700. Dow Jones followed by passing over 25,000. Who can ask for a better start?

However, with S&P 500 earning +22% and Nasdaq gaining 32% in 2017, many are wondering if the equity market has any fuel left for another big run. With momentum on its side, the recent corporate tax cuts, and president’s promises for deregulation we have the foundation for another record high year. But not everything is perfect. In times of market euphoria, investors tend to ignore warning signals.

Surely, there is no shortage of potential threats that can trigger another significant market correction or an economic recession. In my view, here are the biggest risks for the market in 2018 and beyond.

Learn more about our Private Wealth Management services

Government shutdown

With the start of the year, both Republicans and Democrats are gearing for a battle as the current government funding bill expires on January 19.

Republicans are invigorated after winning their most important battle of 2017. The GOP voted for the most extensive tax overhaul in 30 years which promises to cut taxes for corporations and middle class but also introduces additional $1.5 trillion to the budget deficit in 10 years without counting for growth. Their 2018 agenda includes cutting entitlements, building a border wall, financing a new infrastructure plan, increasing the military budget and maybe repealing Obamacare.

On the opposite end, after their win in the Alabama senate race, Democrats are slowly recovering from their knockdown phase after the US 2016 Presidential election.  Democrats will try to push their agenda on the Dreamers Act and save the government healthcare subsidies.

With a slim Senate majority and traitorous rifts inside the party, the GOP will have a hard time passing any significant legislation. The Senate leadership already expressed their desire to work with Democrats on the next bill on avoiding a government shutdown. While the public may appreciate a bi-partisan agreement, both parties have shown an enormous resistance to compromise on any level.

Geopolitical crisis

There is a growing number of geopolitical threats that can compromise the global growth. The world is becoming a treacherous place where one miscalculation can lead to a human disaster. From cyber-war with Russia to nuclear tension with North Korea, ongoing unrest in the Middle East, shutting down NAFTA, populist governments taking over Europe, and hard Brexit negotiations.

China is looking to fill the vacuum left by the US after scrapping the Trans-Pacific Trade Agreement.  Russia and President Putin want to play a bigger role in the world affairs. The remnants of ISIS are spread around the world and planning the next terrorist attack. The 16-year war in Afghanistan is still going with no resolution in sight. The tension between Iran and Saudi Arabia is on its highest level for years. The president must maneuver carefully in the dangerous waters of world politics where governments are becoming more and more protectionist and populist.

Health Care Chaos

The GOP was unsuccessful in repealing the Affordable Care Act. However, they were able to remove the individual mandate as part of the recent tax cut bill.

With the penalty going away in 2019, there will be no incentive for healthier individuals to sign up for health insurance.  Furthermore, this will lead to a lower number of insured participants and drive higher their cost of health care.

US has already the most expensive health care among all OECD counties. The average cost per individual in the USA is $10,000 versus $6,700 for Switzerland and $5,100k for Germany. The Congress and Senate must find a solution to address the climbing health care cost. The alternative will lead to more healthy people dropping from the system, skyrocketing medical bills, social unrest,  and even economic slowdown.

Retail meltdown

US retail is in danger. In 2017, 19 retailers including Toys R US, Aerosoles, Perfumania, True Religions and Gymboree filed for bankruptcy protection. Many others like Teavana, Bebe, and Kenneth Cole closed all their physical locations to focus on online expansion. Despite rising consumer confidence and record-high holiday shopping spree, traditional brick-and-mortar retailers are struggling to stay afloat.

Apart from a few big names, US retailers are loaded with debt. According to Bloomberg, $100 million of high-yield retail debt was set to mature in 2017. Furthermore, this figure will rise to $1.9 billion in 2018 and will average $5 billion between 2019 to 2025. With rising interest rates and permanent drift towards online shopping, many retailers will continue to close down unprofitable locations. Local economies relying heavily on retail jobs will suffer high unemployment rates in the coming years.

Consumer debt crunch

The US household debt has reached $13 trillion in the third quarter of 2017, according to the New York Fed. Driven by low-interest rates, the mortgage debt increased to $8.7 trillion. Student debt has reached $1.36 trillion. Auto loan debt is $1.2 trillion. While mortgage delinquencies are stable at 1.2%, bad auto loans have risen to 2.4%, and student debt delinquencies have reached 9.6%.  The rising interest rates can lead to more people failing on their loans, which can potentially trigger another crisis similar to 2008.

Interest hikes and hyperinflation

The US fed is planning for three rate hikes in 2018. Oil has slowly passed $60 a barrel. And US dollar reached 1.20 against the euro. Moreover, U.S. manufacturing expanded in 2017, as gains in orders and production capped the strongest year for factories since 2004.  While around the world factories have warned they are finding it increasingly hard to keep up with demand, potentially forcing them to raise prices.

While CPI hovers around 1.7%, global markets have not priced in the prospects for higher inflation. Therefore, unexpected spike in prices can lead to more Fed rate hikes.

Additionally, the lost corporate tax revenue can jeopardize the ability of the US Treasury to issue debt at lower rates, which can drive the budget deficit even further. Historically, uncontrolled inflation combined with growing budget deficit has led to periods of hyperinflation, higher credit cost and loss of purchasing power.

Retirement savings going down

Only half of US families have a retirement account. The 401k plan patriation is only 43%. Of those with retirement savings, the average balance is just $60,000. Social Security ran $39 billion deficit in 2014 and will be entirely depleted by 2035.

With rising interest rates and GOP plans to cut entitlements, many Americans will face enormous retirement risk and suffer substantial income loss during their non-working years. Without an urgent reform, the US social security system is a time-ticking bomb that can hurt both businesses and families.

Mueller investigation

The former FBI chief investigation is at full speed as more revelations about the Trump campaign appear almost on a daily basis. You might need a crystal ball to predict what will be the exact outcome. However, it is virtually certain that there were people in the Trump circle who were pursuing their own personal interests. The initial theory of collusion and obstruction of justice is leading to allegations about money laundering. If the Mueller investigation proves those accusations, we could experience a political crisis not seen since Watergate.

 

About the author: Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm. Babylon Wealth Management offers highly customized Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans and other institutional clients. To learn more visit our OCIO page here.

Market Outlook December 2017

Market Outlook December 2017

Market Outlook December 2017

As we approach 2018, it‘s time to reconcile the past 365 days of 2017. We are sending off a very exciting and tempestuous year. The stock market is at an all-time high. Volatility is at a record low. Consumer spending and confidence have passed pre-recession levels.

I would like to wish all my readers and friends a happy and prosperous 2018. I guarantee you that the coming year will be as electrifying and eventful as the previous one.

 

The new tax plan

The new tax plan is finally here. After heated debates and speculations, president Trump and the GOP achieved their biggest win of 2017. In late December, they introduced the largest tax overhaul in 30 years. The new plan will reduce the corporate tax rate to 21% and add significant deductions to pass-through entities. It is also estimated to add $1.5 trillion to the budget deficit in 10 years before accounting for economic growth.

The impact on the individual taxes, however, remains to be seen. The new law reduces the State and Local Tax (SALT) deductions to $10,000. Also, it limits the deductible mortgage interest for loans up to $750,000 (from $1m). The plan introduces new tax brackets and softens the marriage penalty for couples making less than $500k a year. The exact scale of changes will depend on a blend of factors including marital status, the number of dependents, state of residency, homeownership, employment versus self-employment status. While most people are expected to receive a tax-break, certain families and individuals from high tax states such as New York, New Jersey, Massachusetts, and California may see their taxes higher.

 

Affordable Care Act

The future of Obamacare remains uncertain. The new GOP tax bill removes the individual mandate, which is at the core of the Affordable Care Act. We hope to see a bi-partisan agreement that will address the flaws of ACA and the ever-rising cost of healthcare. However, political battles between republicans and democrats and various fractions can lead to another year of chaos in the healthcare system.

 

Equity Markets

The euphoria around the new corporate tax cuts will continue to drive the markets in 2018. Many US-based firms with domestic revenue will see a boost in their earnings per share due to lower taxes.

We expect the impact of the new tax law to unfold fully in the next two years. However, in the long run, the primary driver for returns will continue to be a robust business model, revenue growth, and a strong balance sheet.

Momentum

Momentum was the king of the markets in 2017. The strategy brought +38% gain in one of its best years ever. While we still believe in the merits of momentum investing, we are expecting more modest returns in 2018.

Value

Value stocks were the big laggard in 2017 with a return of 15%. While their gain is still above average historical rates, it’s substantially lower than other equity strategies.  Value investing tends to come back with a big bang. In the light of the new tax bill, we believe that many value stocks will benefit from the lower corporate rate of 21%. And as S&P 500 P/E continues to hover above historical levels, we could see investors’ attention shifting to stocks with more attractive valuations.

Small Cap

With a return of 14%, small-cap stocks trailed the large and mega-cap stocks by a substantial margin. We think that their performance was negatively impacted by the instability in Washington. As most small-cap stocks derive their revenue domestically, many of them will see a boost in earnings from the lower corporate tax rate and the higher consumer income.

International Stocks

It was the first time since 2012 when International stocks (+25%) outperformed US stocks. After years of sluggish growth, bank crisis, Grexit (which did not happen), Brexit (which will probably happen), quantitative easing, and negative interest rates, the EU region and Japan are finally reporting healthy GDP growth.

It is also the first time in more than a decade that we experienced a coordinated global growth and synchronization between central banks. We hope to continue to see this trend and remain bullish on foreign markets.

Emerging Markets

If you had invested in Emerging Markets 10-years ago, you would have essentially earned zero return on your investments. Unfortunately, the last ten years were a lost decade for EM stocks. We believe that the tide is finally turning. This year emerging markets stocks brought a hefty 30% return and passed the zero mark. With their massive population under 30, growing middle class, and almost 5% annual GDP growth, EM will be the main driver of global consumption.

 

Fixed Income

It was a turbulent year for fixed income markets. The Fed increased its short-term interest rate three times in 2017 and promised to hike it three more times in 2018. The markets, however, did not respond positively to the higher rates. The yield curve continued to flatten in 2017. And inflation remained under the Fed target of 2%.

After a decade of low interest, the consumer and corporate indebtedness has reached record levels. While the Dodd-Frank Act imposed strict regulations on the mortgage market, there are many areas such as student and auto loans that have hit alarming levels. Our concern is that high-interest rates can trigger high default rates in those areas which can subsequently drive down the market.

 

Gold

2017 was the best year for gold since 2010. Gold reported 11% return and reached its lowest volatility in 10 years.  The shiny metal lost its momentum in Q4 as investors and speculators shifted their attention to Bitcoin and other cryptocurrencies. In our view gold continues to be a solid long-term investment with its low correlation to equities and fixed income assets.

 

Real Estate

It was a tough year for REITs and real estate in general. While demand for residential housing continues to climb at a modest pace, the retail-linked real estate is suffering permanent losses due to the bankruptcies of several major retailers. This trend is driven on one side by the growing digital economy and another side by the rising interest rates and the struggle of highly-leveraged retailers to refinance their debt. Many small and mid-size retail chains were acquired by Private Equity firms in the aftermath of the 2008-2009 credit crisis. Those acquisitions were financed with low-interest rate debt, which will gradually start to mature in 2019 and peak in 2023 as the credit market continues to tighten.

Market Outlook December 2017

In the long-run, we expect that most public retail REITs will expand and reposition themselves into the experiential economy by replacing poor performing retailers with restaurants and other forms of entertainment.

On a positive note, we believe that the new tax bill will boost the performance of many US-based real estate and pass-through entities.  Under the new law, investors in pass-through entities will benefit from a further 20% deduction and a shortened depreciation schedule.

 

What to expect in 2018

  • After passing the new tax bill, the Congress will turn its attention to other topics of its agenda – improving infrastructure, and amending entitlements. Further, we will continue to see more congressional budget deficit battles.
  • Talk to your CPA and find out how the new bill will impact your taxes.
  • With markets at a record high, we recommend that you take in some of your capital gains and look into diversifying your portfolio between major asset classes.
  • We might see a rotation into value and small-cap. However, the market is always unpredictable and can remain such for extended periods.
  • We will monitor the Treasury Yield curve. In December 2017 the spread between 10-year and 2-year treasury bonds reached a decade low at 50 bps. While not always a flattening yield has often predicted an upcoming recession.
  • Index and passive investing will continue to dominate as investment talent is evermore scarce. Mega large investment managers like iShares and Vanguard will continue to drop their fees.

 

Happy New Year!

 

Final words

If you have any questions about your existing investment portfolio, reach out to me at [email protected] or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

 

End of Summer Market Review

End of Summer Market Review

Happy Labor Day!

Our hearts are with the people of Texas! I wish them to remain strong and resilient against the catastrophic damages of Hurricane Harvey. As someone who experienced Sandy, I can emphasize with their struggles and hope for a swift recovery.

 

I know that this newsletter has been long past due. However, as wise people say, it is better late than never.

It has been a wild year so far. Both Main and Wall Street kept us occupied in an electrifying thriller of election meddling scandals, health reforms, political battles, tax cuts, interest rate hikes and debt ceiling fights (that one still to unfold).

Between all that, the stock market is at an all-time high. S&P 500 is up 11.7% year-to-date. Dow Jones is up 12.8%, and NASDAQ is up to the whopping 24%. GDP growth went up by 3% in the second quarter of 2017. Unemployment is at a 10-year low. 4.3%.

Moreover, despite record levels, very few Americans are feeling the joy of the market gains and feel optimistic about the future. US families are steadily sitting on the sideline and continuing to pile cash. As of June 2007, the amount of money in cash and time deposits (M2) was 70.1% of the GDP, an upward trend that has continued since the credit crisis in 2008.

End of Summer Market Review

Source: US Fed, https://fred.stlouisfed.org/graph/?g=dZn

Given that the same ratio of M2 as % of GDP is 251% in Japan, 193% in China, 91% in Germany, and 89% in the UK, US is still on the low end of the developed world. However, this is a persistent trend that can reshape the US economy for the years to come.

 

The Winners

This year’s rally was all about mega-cap and tech stocks. Among the biggest winners so far this year we have Apple (AAPL), up 42%, Amazon (AMZN), 27%, NVIDIA (NVDA), 54%, Adobe, 48%, PayPal, 55%. Netflix, 36%, and Visa (V), 33%,

Probably the biggest story out there is Amazon and its quest to disrupt the way Americans buy things. Despite years of fluctuating earnings, Amazon is still getting full support from its shareholders who believe in its long-term strategy. The recent acquisition of Whole Foods and announcement of price drops, only shows that Amazon is here to stay, and all the key retail players from Costco, Wall-Mart, Target, and Walgreens to Kroger’s, Home Depot, Blue Apron and AutoZone will have to adjust to the new reality and learn how to compete with Amazon.

The Laggards

Costco, Walgreens, and Target are bleeding from the Amazon effect as they reported- 0.49%, -0.74% and -21% year-to-date respectively. Their investors are become increasingly unresponsive to earnings surprises and massively punishing to earnings disappointments.

Starbucks, -0.74%, is still reviving itself after the departure of its long-time CEO, Howard Shultz, and will have to discover new revenue channels and jump-start its growth.

The energy giants, Chevron, -5%, Exxon, -12%, and Occidental Petroleum, -14.5% are still suffering from the low oil prices. With OPEC maintaining current production levels and surge in renewable energy, there is no light at the end of the tunnel. If these low levels continue, I will expect to see a wave of mergers and acquisitions in the sector. Those with a higher risk and yield appetite may want to look at some of the companies as they are paying a juicy dividend – Chevron, 4%, Exxon, 4%, and Occidental Petroleum, 5.4%

AT&T, -7% and Verizon, -5%, are coming out of big acquisitions, which down-the-road can potentially create new revenue channels and diversify away from the otherwise slow growing telecom business. In the near-term, they will continue to struggle in their effort to impress their investors. Currently, both companies are paying above average dividends, 5.15%, and 4.76%, respectively.

And finally, Wells Fargo, -4%. The bank is suffering from the account opening scandals last year and the departure of its CEO.  The stock has lagged its peers, which reported on average, 8% gains this year. While the long-term outlook remains positive, the short-term prospect remains uncertain.

 

Small Caps

Small Cap stocks as an asset class have not participated in this year’s market rally. Despite spectacular 2016 returns, small cap stocks have remained in the shadow of the uncertainty of the expected tax cuts and infrastructure program expansion. While I believe the Congress will come out with some tax reductions in the near term, the exact magnitude is still unclear. My long-term view of US small caps remains bullish with some near-term headwinds.

 

International Stocks

After several years of lagging behind US equity markets, international stocks are finally starting to catch up. The Eurozone reported 2% growth in GDP. MSCI EAFE is up 17.5% YTD, and MSCI Emerging Markets is up 28% YTD.

Despite the recent growth, International Developed and Emerging Market stocks remain cheap on a relative basis compared to US Stocks.  I maintain a long-term bullish view on international and EM stocks with some caution in the short-term.

Even though European Central Bank has kept the interest rates unchanged, I believe that its quantitative easing program will slow down towards the end of 2017 and beginning of 2018. The German bund rates will gradually rise above the negative levels. The EUR / USD will breach and remain above 1.20, a level not seen since 2014.

Interest Rates

I am expecting maximum one or may be even zero additional rate hikes this year. Under Janet Yellen, the Fed will continue to make extremely cautious and well-measured steps in raising short term rates and slowing down of its Quantitative Easing program. Bear in mind that the Fed has not achieved its 2% inflation target and any sharp rate hikes can ruin the already fragile balance in the fixed income space.

Real Estate

After eight years of undisrupted growth, US Real Estate has finally shown some signs of slow down. While demand for Real Estate in the primary markets like California and New York is still high, I expect to see some cooling off and normalization of year-over-year price growth

US REITs have reported 3.5% total return year-to-date, which is roughly the equivalent of -0.5% in price return and 4% in dividend yield.

Some retail REITs will continue to struggle in the near-term due to store closures and pressure from online retailers. I encourage investors to maintain a diversified REIT portfolio with a focus on strong management, sustainability of dividends and long-term growth prospects.

Gold

After several years of underperformance, Gold is making a quiet comeback. Gold was up 8% in 2016 and 14% year-to-date. Increasing market and political uncertainty and fear of inflation are driving many investors to safe havens such as gold. Traditionally, as an asset class, Gold has a minimal correlation to equities and fixed income. As such, I support a 1% to 5% exposure to Gold in a broadly diversified portfolio as a way to reduce long-term risk.

 

About the author: Stoyan Panayotov, CFA is a fee-only investment advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

 

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

 

Will Small Caps continue to rally under Trump Presidency?

Small Cap stocks are a long-time favorite of many individual investors and portfolio manager. The asset class jumped 38% since the last election. Will Small Caps continue to rally under Trump Presidency? Can they maintain their momentum?

The new president Trump started with promises for domestic business growth, lower taxes, and deregulation. While details are still unclear, if implemented correctly, these policies can bring significant benefits to small size companies.

The recent growth comes after five years of sluggish performance. Before the 2016 election, the Russell 2000 had underperformed S&P 500 500 by almost 2% annually, 11.59% versus 13.44%.  Small-cap stocks have been very volatile and fragmented. As a result, many active managers have underperformed passive index strategies.

 

Low tax rates

The average US corporate tax rate is 39.1% which includes 35% federal tax and 4.1% average state tax. USA has the highest corporate tax among OECD countries, which have an average of 29% tax rate. While large multinationals with their corporate lawyers can take advantage of cross-border tax loopholes, the same is not possible for smaller businesses. Dropping the tax rate to the suggested 20% will give small caps a breath of fresh air. It will allow them to have more available cash, which they can use for hiring more talent, R&D or dividends.

Deregulation

Regulations are typically set to protect the consumer and the environment from businesses which prioritize profit margins over safety. Therefore, lifting regulations will be a tricky game. If the streamlining leads to more competition, better customer experience, less bureaucracy, and faster processing of business requests to governing bodies, then deregulation will help smaller business thrive further and be more competitive.

 Infrastructure

I drive a lot around the San Francisco Bay Area and can ensure you that every highway with “80” in the name is in dire need of major TLC. The same story is probably true for many major cities and industrial centers. If the executed correctly, the infrastructure policy can boost small business growth. Local companies can bid for infrastructure projects or participate as subcontractors. Improved infrastructure can also help goods and produce to arrive faster and safer and ultimately drive down cost.

Domestic production incentives

With the current strong dollar and liberal trading policy, the small business has struggled to compete against imports, which rely heavily on cheap labor and often on local government subsidies. Certain industries like textile and electronics are almost non-existent in the US.

Nevertheless, I think setting embargos and trade wars with other countries will be a step in the wrong direction. Alternatively, The US government should support industries that offer innovative, high quality, customized and niche products, which can dominate the global markets.

 

While the markets are currently optimistic about the success of the new economic policies, things can still go wrong. The markets had a long rally since the end of the bear market in March 2009. At the current level, both large and small-cap companies have reached rich valuations, and stock prices are factoring the proposed economic policies. The stock market may react abruptly if the new administration fails to deliver their promises.

Some of the side effects of the new policies need to be in consideration as well.

Rising interest rates

The 10-year Treasury jumped from 1.5% in July 2016 to 2.47% today. While high-interest rates have been welcomed by many market players, they can hurt the small business’ ability to get new loans. Many companies rely on external financing to fund their daily business activities, R&D, and expansions. Higher interest rates will increase the cost and affect the bottom line of those companies that traditionally use loans as part of their business and have less access to internal resources.

Another caveat in this topic is the proposed change to eliminate the interest as a tax deduction. While still up-in-the-air, this proposal will further affect those companies that depend on external loans for financing.

Inflation

Inflation is healthy for the economy when it’s a result of organic economic growth, innovation, productivity, and consumer demand. However, if let out of control, inflation will undermine the purchasing power of the dollar, push down consumer demand and increase the cost of domestic goods and services.

Strong dollar

Small cap companies are traditionally focused on the local US market. However, a strong dollar can make imports more price competitive against local products. The strong dollar also affects negatively business relying on exports. It makes US exports more expensive in local currencies.

Immigration

It’s a known fact that US firms tap into a foreign talent to fill out jobs that are not in high supply by domestic job seekers. Usually, the biggest portion of visa workers goes to larger companies. However, stricter immigration laws can still hurt the ability of small firms to hire foreign talent and compete against their larger rivals. Many tech start-ups, financial and biotech companies rely on foreign visa workers to fill out certain roles whenever they cannot find qualified US candidates. Agriculture and tourism businesses also depend on foreign workers to fill in seasonal positions. Tighter immigration rules will force these companies to increase salaries to remain competitive. Higher salaries will drive higher cost and lower profit margins.

 

Conclusion

While we are in a standby mode, the market continues to be nervous in anticipation of the direction of the new policies. For those interested in small-cap stocks, I would suggest looking for companies with an innovative business model, solid R&D and high-quality metrics like ROA and ROE. Those companies are likely to be more resilient in the long run, and less depended on policy changes.

 

Final words

If you have any questions about your existing investment portfolio, reach out to me at [email protected] or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

6 Proven strategies for volatile markets

Proven strategies for volatile markets

What are some of the proven strategies for volatile markets? The truth is nobody likes to lose money. Especially money that is earmarked for retirement, vacation, real estate purchase, or college education. Today’s volatile markets can be treacherous for inexperienced (and even experienced) investors.  Successful investors must remain focused on the strength of their portfolio and the potential for future growth.

The stock market can be volatile.

The first instinct when the market drops is to sell your investments. Well, in reality, this may not always be the right move. Selling your stocks during market selloff may limit your losses, may lock in your gains but also may lead to missed long-term opportunities. Emotional decisions do not bring a rational outcome.

How low can the market go?  The largest-ever percentage drop by the S&P 500 index occurred on October 19, 1987 (known as The Black Monday) when the S&P 500 dropped by -20.47%. The next biggest sell-off happened on October 15, 2008, when the S&P 500 lost –9.03%. In both cases, the stock market continued to be volatile for several months before reaching a bottom. The bottom was the start of a new bull market. Both times, the stock market recovered to reach historic highs in a few years.  In the past seven years, the S&P 500 rose up by 14.8%, which is almost double the historical average of 7%.

So what can you do when the next market crash happens?

I want to share six strategies that can help you through the turbulence and support the long-term growth of your portfolio.

1. Keep calm and carry on

One of the most proven strategies for volatile markets is staying callm. Significant drops in stock value can trigger panic—and fear-based selling to limit losses is the wrong move.  Here’s why: frequently these market selloffs are followed by broad market rallies. As long as you are making sound investment choices, patience and the ability to tolerate paper losses will earn you more in the long run.

2. Be realistic: Don’t try to time the market

Many investors believe that they can time the market to buy low and sell high. In reality, very few investors succeed in these efforts.

According to a study by the CFA Institute Financial Analyst Journal, a buy-and-hold large-cap strategy would have outperformed, on average, about 80.7% of annual active timing strategies when the choice was between large-cap stocks, short-term T-bills and Treasury bonds.

3. Stay diversified

Diversification is essential for portfolio preservation and growth. Diversification, or spreading your investments among different asset categories (stocks, bonds, real estate, commodities, precious metals, etc.) minimizes risk.

Uncorrelated asset classes react uniquely during turbulent markets and economic cycles.

For example, fixed income securities and gold tend to rise during bear markets when stocks fall. Conversely, equities rise during economic expansion.

4. Focus on your long-term goals

Personal financial goals stretch over several years. For investors in their 20s and 30s financial goals can go beyond 30 – 40 years. Staying disciplined—maintaining a high credit score, minimizing debt, and developing a savings plan–is the best way to achieve your goals.

Market crises come and go, but your goals will most likely remain the same. In fact, most goals have nothing to do with the market. Your investment portfolio is just one of the ways to achieve your goals.

5. Use tax-loss harvesting

If you own taxable accounts, you can take advantage of tax-loss harvesting opportunities. You can sell securities at depressed prices to offset other capital gains made in the same year. Also, you can carry up to $3,000 of capital losses to offset other income from salary and dividends. The remaining unused amount of capital loss can also be carried over for future years for up to the allowed annual limit.

To take advantage of this option you have to follow the wash sale rule. You cannot purchase the same security in the next 30 days. To stay invested in the market you can substitute the depressed stock with another stock that has a similar profile or buy an ETF.

6. Be opportunistic

Market swings create opportunities for purchasing securities at a discounted price.

Not surprisingly the renowned investor Warren Buffet‘s famous words are “Buy when everyone else is selling” and “When it’s raining gold, reach for a bucket, not a thimble.”

Market selloffs rarely reflect the real long-term value of a company. Usually, selloffs are triggered by market news, political events, and most recently by algorithmic errors. Market drops during volatile times are an excellent opportunity for investors to buy their favorite stocks at a lower price.