Working Without a Net
FC Advisors Quarterly Investment Update – Q1 2018
What is it about heights that can make walking in a straight line suddenly become challenging? There’s nothing remarkable about walking in a straight line, but when you put a tight rope high enough above the ground, the task goes from pedestrian to petrifying. Is it really harder to walk on a tight rope that is 12 inches off the ground than it is to walk on a tight rope that is 12 feet off the ground? The task itself has not changed, but the perceived danger has; and that, for most of us, alters our thought process and behavior. It’s a lot easier to relax and focus on the task at hand when you know you have a safety net.
For the past nine years, financial markets have been working with a net. The Federal Reserve’s policies of keeping interest rates low and acting to soothe financial markets at any sign of stress, have emboldened investors while simultaneously boosting the prices of stocks & bonds. But in the first quarter of 2018, new leadership took over at the Federal Reserve. The new chairman, Jerome Powell, seems intent on removing the low interest rate safety net. Has investment performance in recent years been more about confidence in the underlying strength of businesses, or has it been more about confidence in the Federal Reserve’s safety net?
We tend to think that low interest rates have played a larger role than normal in investment performance. Interest rates (the price of money) are the most important prices in the market, the price of virtually all other assets flows from them in one way or another. The relationship with bonds is so direct that it is virtually mechanical, lower interest rates = higher bond prices. With other assets such as stocks the connection is less direct and subject to change. Indeed, conventional wisdom is that stocks are the best place to be when interest rates rise. However, over the past nine years stocks may have become more connected to interest rates than many people think. Low interest rates have made the earnings in stocks look relatively more attractive and they have helped to boost those very same earnings, particularly on a per share basis. Thus, in more ways than one, the strong performance in the stock market since 2009 has also been very dependent on low interest rates. We much prefer investing in a market that can stand on its own merit, but we expect more jitters for both stocks and bonds during the transition.
- The Quarter in Review
- Sentiment & Value Update
- High Yield Savings
The Quarter in Review
After a relentless climb higher in January, stock prices fell sharply and volatility roared back leaving the S&P 500 and international stocks down slightly for the quarter. Meanwhile, bonds, which had been consistently rallying during any period of weakness in the stock market, sold off as well. Crypto-currencies, America’s favorite Thanksgiving 2017 dinner conversation, also sold off hard with the majority down by 50% or more versus the US dollar. It was a difficult quarter with very few places to hide.
Relevant Index Performance
Total Returns as of 3/29/18
Index Qtr to Date Trailing 12 Months
S&P 500 -0.76% 13.99%
MSCI World ex-US -1.92% 14.46%
MSCI Emerging Mkts 1.47% 25.37%
S&P Municipal Index -0.92% 2.53%
10-Year Treasury -1.50% -0.49%
Sentiment & Value
The chart above shows our opinion on where various markets are as of March 29th 2018. Many of the best purchase decisions are made when prices are cheap and sentiment is bearish or depressed (bottom left quadrant). Conversely, many of the best sell decisions are made when prices are expensive and sentiment is bullish or euphoric (top right quadrant).
The combination of tax cuts, an increase in government spending and an increase in government debt issuance have increased the odds of both rising inflation and rising interest rates. We see this development as negative for both stocks and long-term bonds. We also expect that markets will react to these changes unevenly, with the most obviously interest rate sensitive areas adjusting sooner than others. Certain pockets of the market such as commodities have become more attractive and are cheap relative to stock prices. That said, most asset classes remain expensive and we continue to favor a more conservative position for our portfolios at this time. All things being equal, if the S&P 500 were to trade below 2,400, we would be interested in buying US stocks and if the 10-year treasury yielded more than 3.25% we would be adding to long-term bond positions.
High Yield Savings Accounts
Issue: Traditional brick and mortar banks are still paying almost nothing on deposits, but they are not the only game in town.
Impact: Many savers are missing out on an opportunity to earn a significantly higher rate on their cash reserves.
FC Advisors’ Take: The Federal Reserve has raised interest rates from 0.0% back in 2015 to 1.5% as of March 2018. Despite this significant increase in the rates that banks receive from the Federal Reserve, most “brick & mortar” banks have barely raised the rates they pay to savers. The largest US banks (JP Morgan Chase, Bank of America, Wells Fargo & Citibank) pay an average of less than 0.10% annually on savings accounts. Meanwhile, there are several reputable online banks that pay up to 1.60% annually. These banks are backed by the same FDIC coverage that savers count on at “brick & mortar” banks and they can be easily linked to an existing checking, savings and/or investment account. The only thing preventing savers from getting fair compensation on their savings is a lack of initiative. Opening and linking one of these accounts takes less than 30 minutes and they are an excellent place to put your emergency savings. If you don’t have some extra cash set aside (your own personal safety net) to help you stay calm during financial stress, now is an excellent time to set one up. How much more could your savings account earn?
Issue: In 2017 there were only 8 days on which the S&P 500 moved up or down by 1% or more. The first quarter of 2018 logged 23 of these big 1%+ moves.
Impact: Volatility taps into our emotions and can cause investors to act irrationally. This tends to increase the risk of buying high and selling low. Big up moves often trigger greed or fear of missing out on gains, while big down moves can cause investors to sell in a panic.
FC Advisors’ Take: An increase in volatility has been long overdue. According to LPL research, the average year since 1951 has experienced 50 days with a 1%+ move (up or down) in the S&P 500. The highest ever was 134 in 2008 and the lowest ever was 3 in 1964. Our current pace is for 92 in 2018, about double the average. Because volatility has been suppressed for so long, it would not surprise us if we continued to experience higher than average volatility for a while. The important thing to remember is that for long-term investors, volatility creates opportunity. For those with discipline and a focus on buying at a fair price, volatility is one of the market inefficiencies that we can benefit from in the long-term.
But, there are three key concepts investors must understand in order navigate volatility successfully.
- It may not feel like we are getting a great deal in the moment.
- There is no way to guarantee that we will be able to buy on the lowest or last down move.
- Regardless of the headlines & outside noise, we must maintain discipline and focus on buying at an attractive price.
Issue: President Trump has been talking tough on trade, including levying import tariffs on foreign goods. In response, some US trading partners have threatened retaliatory tariffs, sparking fears of a trade war.
Impact: Global trade has become very interconnected. A trade war would be very disruptive and it could easily cause a recession and/or inflation.
FC Advisors’ Take: Until any tariffs are actually implemented, there is no trade war. Trade is fundamentally a competitive endeavor. While there are often opportunities for win/win outcomes, interested parties are constantly competing to get the best price. International trade relationships are even more complex than domestic trade relationships. These relationships are impacted by currency fluctuation, differing legal and regulatory frameworks, differing labor and input costs, transportation costs and of course tariffs. To further complicate things, all these variables are constantly adjusting dynamically. In theory, tariffs should be used to counterbalance any unfair advantages created by the other variables, but in practice they are often used in reaction to domestic political pressure. With so many variables at work, negotiating international trade relationships is a challenging and messy process.
We suspect that the threats we have seen publicly have often been an integral part of negotiations that historically took place behind closed doors. To the extent that these tactics can help the US barter a better deal with some of its trading partners, we believe it can still be a net positive for the country. However, we can’t help but notice that the tone of US trade communications has shifted decisively from an effort to collaborate in order to find win/win opportunities to a threatening tone in which the US seems to be approaching trade as a zero-sum game. This dynamic is cause for concern and could increase the risk of inflation if we continue down a protectionist path. But, for now, we think most of the day-to-day market reactions and headlines are overdone.
Downloadable PDF 2018 Q1 Investment Update
If you have questions about these topics or any other financial needs, please contact
FC Advisors at:
Following Claire Advisors, LLC DBA FC Advisors is a Registered Investment Adviser. This brochure is solely for informational purposes and is not intended to provide investment advice. Advisory services are only offered to clients or prospective clients where FC Advisors and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by FC Advisors unless a client service agreement is in place.