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When to Crack Your Nest Egg: Part II

In our January blog post, we explored the question of when to retire—more specifically, the portfolio implications of retiring at what could be the beginning of a bear market. In light of recent volatility in public markets and anticipation of a long overdue downturn, sequencing risk is of particular interest to clients approaching or considering retirement—and understandably so.

For those who cannot or don’t want to wait to retire under more favorable market conditions, there are specific strategies we recommend for mitigating sequencing risk. These contingency plans help us to focus on those things we can control and to feel more confident in our preparation. Before cracking that nest egg, we suggest you consider:

Retirement Buckets

A distribution or “bucket” strategy provides short-term certainty without sacrificing long-term security by divvying up your retirement funds into buckets that differ in asset type, purpose, and time frame. For example, you might create three buckets as follows:

  • Cash (or cash equivalents) to be used for the upcoming year or two of expenses. This provides a regular source of cash without feeling pressured to liquidate other investments at an inopportune time; instead, those assets can stay invested while waiting for the market to rally.
  • Bonds and fixed-income investments, which are less prone than stocks to suffer significant market downturn. A properly structured bond portfolio can serve as a well-defined annual source of investment income to help replenish Bucket 1 if needed.
  • Stocks (or other equity investments) to sustain the nest egg for the long term. When market performance exceeds expectations, the excess appreciation can be used to replenish Buckets 1 and 2 if needed. On the other hand, when performance disappoints, Buckets 1 and 2 carry you through without having to sell stocks at a point of lower (or no) returns, providing critical peace of mind to stay the course and ride out market volatility.

Flexible Budgets

Spending needs change over time, and the same is true during retirement. Perhaps you hope to enjoy lower budgetary needs now that the kids are grown; perhaps your medical costs will unexpectedly rise in the years to come; or perhaps you hope to celebrate your freedom with an extravagant trip abroad.

We strongly encourage all our clients – not just those facing possible sequencing risk – to take a hard look at how they currently spend their money, set honest expectations around how those budgetary needs might change (for better or worse) during retirement, and quantify the cash flow realistically needed to retire. During this exercise, build in flexibility by identifying any items which might be postponed or eliminated should the market turn (for example, that trip abroad can probably wait, while medical expenses probably can’t).

Additionally, withdrawing a percentage of your retirement funds each year – rather than a fixed amount – further mitigates sequencing risk by reducing the impact of your withdrawals on top of the impact of lower returns. However, this strategy requires that you be able to live within a spending range that might fluctuate from one year to the next based on market performance, rather than adhering to a fixed annual budget.

Withdrawal Sequencing

Be thoughtful when prioritizing accounts for withdrawals. While fulfilling your Required Minimum Distribution amounts from your IRA or 401(k) comes first, consider following with more tax efficient non-taxable withdrawals from an HSA or Roth account.  Individual situations may vary, so be sure to work with a tax advisor to optimize the impact on your tax liabilities.

Buffer Asset Inventory

Take stock of any assets you may have that can be used, if necessary, to buffer cashflow shortfalls during a market downturn. Consider the cash surrender value of a life insurance policy, or selling that rarely used lake house. Despite the negative reputation of reverse mortgages, there are situations in which even these can be effective tools for supplementing retirement income.

Of course, you may choose to employ one, two, or all of these mitigating strategies to best prepare yourself for retirement, even if the market’s timeline doesn’t seem to align with yours. When in doubt, always seek the advice of a professional who can help you weigh your options and develop a thoughtful, well-rounded retirement plan that ensures you spend those golden years focused on filling the soul, not the coffers.

 

Suzanne T. Mestayer

 

For disclosures, please click here.

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When to Crack Your Nest Egg

Retirement: it’s a phase of life many look forward to, but it’s also one of the hardest to plan.  Sure, there’s the question of how much, often referred to as your “number”—the amount of savings you’d need to be able to comfortably retire. Conventional wisdom has long relied on the “4% Rule” to help hopeful retirees calculate this number: the annual income you want or need throughout retirement (not including Social Security income) should represent 4% of your total savings upon retirement. So, if you’re targeting $150,000 in annual retirement income, you’ll need $3.75 million saved the day you retire.

While this rule of thumb may be helpful in its simplicity, that simplicity can leave many ill-prepared for the financial realities of retirement.

While the 4% Rule asks how much, it doesn’t ask how long. The 4% Rule assumes a 30-year retirement. If you don’t expect to live that long, perhaps you don’t need the full $3.75 million. Then again, if you midjudge your longevity, you could deplete your savings years too soon.

The 4% also doesn’t ask how you expect to live during retirement. In our experience, clients often underestimate how much their current lifestyle really costs, while they overestimate their ability to remain healthy and independent as they age.

Perhaps most importantly in our current market, the 4% Rule fails to ask when.

And when it comes to retirement, it’s not just a question of how big your nest egg is. It’s also a question of when you crack it.

Let’s suppose for a moment that you’ve worked to accurately quantify your retirement needs. You’ve even built in some you wiggle-room for unexpected expenditures. You feel confident in your $3.75 million nest egg number, and you plan to withdraw $150,000 a year. So long as the market is able to return 5% on your investments, your calculations tell you you’re headed for a long, financially secure retirement.

However, in your second year of retirement, the market takes a significant downturn. Suddenly, instead of the 5% return on your investment you’d planned for, your portfolio is now yielding a -12% return rate, as you continue to make withdrawals. After several years, the market rallies, and over the course of your entire retirement, your portfolio still manages to average 5% returns over time. However, averages can be deceiving.

Thanks to that drop in the market early in your retirement, you ate into your nest egg at a faster rate than anticipated, meaning any future market gains were made on a smaller egg. The earlier in your retirement you face a bear market – or worse, a recession – the more magnified is its negative impact and the harder it is for your savings to rebound. This is known as sequencing risk, and it’s of particular concern to those looking to retire just as the market prepares for a downturn.

The fourth quarter of 2018 was certainly such a downturn, and there continue to be predictions of a deeper bear market and possibly a recession.  And while it’s unclear if or when these predictions will come true, those approaching retirement must consider if, when, and how to do so in the face of such uncertainty. Some may decide to continue working to provide extra cushion for their nest egg.   For those who cannot or don’t want to wait, there are specific strategies we recommend for mitigating sequencing risk, including asset allocation strategies, distribution or “bucket” strategies, and flexible spending strategies. These contingency plans will be explored in subsequent blog posts; please stay tuned.

 

Suzanne T. Mestayer

 

For disclosures, please click here.

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So You’re Interested in Sustainable Investing? Consider This…

As discussed in my last blog post, sustainable investing may be one of the most important investment trends of the next decade. It offers investors positive social impact alongside financial returns, and it is catching the eye of individual and institutional investors alike. Globally, more than $1 out of every $4 under professional management is invested sustainably1, as investors—especially women and Millennials—increasingly strive to align their investments with their values. Opportunities for investing sustainably now exist across all asset classes, from private to public, from real estate to fixed income to hedge funds.

However, as with anything new—from a self-driving car to a new job offer to a smartphone software update—we must consider both the benefits and the shortcomings of sustainable investing` before we go all-in. We must proceed with a healthy dose of caution as the market irons out the kinks.

The sustainable investing “movement” is still under development, with much work still to be done to clarify and standardize what it is, how it works, and what success looks like. Even the language used in this space is inconsistent, causing confusion around the various sustainable investment strategies and their nuances. Consider the following terms, often (erroneously) used interchangeably:

  • Socially Responsible Investing (SRI) uses a negative screen for companies believed to offer socially undesirable products or services, like tobacco.
  • Impact Investing focuses on using financial investment to address societal and/or environmental challenges, though many believe this occurs primarily through private markets.
  • ESG Investing evaluates a company’s environmental, social, and governance practices as part of an integrated investment selection process.
  • Thematic Investing (like ThirtyNorth’s Women Impact Strategy) is a more targeted method of addressing specific issues (in our case, a gender lens) in the investment selection process to address gender gaps and disparities. It is often a subcategory of Impact or ESG investing.

Next, consider the lack of standardization around performance evaluation. For starters, it’s not clear what “success” looks like in sustainable investing. Traditionally, higher financial returns have defined higher performance. When it comes to sustainable investing, however, the equation isn’t quite as simple. For some investors, positive social impact may be the end game, even if it means lower financial reward. Others believe a social impact screen is in fact the best path to greater financial outcomes. And other investors live everywhere along the spectrum.

Making matters even more challenging, there are no established and broadly accepted performance metrics, standards, or rating systems in this space. The companies being evaluated for ESG typically self-report these behaviors, introducing ample opportunity for bias. Asset managers and financial advisors offering sustainable investment products often must rely on a limited track record and hypothetical back-testing to demonstrate results. It appears that some companies are even rebranding existing funds as sustainable investment products, regardless of how marginal the ESG or social impact may be.2 These issues make it hard for investors to assess how a particular investment option aligns (or doesn’t) with their goals and nearly impossible for them to make apples-to-apples comparisons across companies, funds, and products. It is no surprise, then, that 70% of institutional asset owners surveyed by Morgan Stanley said that the lack of quality ESG data is one of their biggest challenges when investing sustainably.3

Finally, though numerous sustainable investment products are already on the market or under development—including offerings from virtually every major fund company—many financial advisors have not yet turned their attention to these offerings and may be uninterested in learning about them and/or ill-prepared to discuss them.

So, before diving in…

 

  • Think carefully about who you choose as a partner to guide you through this new terrain,
  • Be sure you and your financial advisor are speaking the same language and are aligned on how you will measure the success of your sustainable investment strategy, and
  • Before accepting the promise of something new at face value, push yourself to dig beyond the hype and review a fund or product for both quality and methodology.

 

Suzanne T. Mestayer

 

1 Global Sustainable Investment Alliance 2016 Report

2 It is Difficult to be an Ethical Investor, Wall Street Journal, September 4, 2018

3 Understanding ESG Ratings: A Brief Primer from Celent, ThinkAdvisor, August 6, 2018

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Bringing Together Money and Meaning: More Than a Tagline

At ThirtyNorth Investments, we steadfastly believe that investment decisions begin and end with an understanding of what money means to you (so much so that we made it our company tagline: Bringing Together Money and Meaning). After all, people don’t seek to accumulate wealth just for the sake of it; they do so with a goal in mind—a vision of how money will help make their lives, their children’s lives, their community, or their world better tomorrow than today.

What we didn’t anticipate when we chose this tagline was that it would foreshadow what is being considered the most important investment trend of the next decade.

Impact Investing—also known as Sustainable Investing or Environment, Social, Governance (“ESG”)—offers investors positive social impact alongside positive financial returns. Not to be confused with philanthropy, Impact Investing is predicated on the belief that companies that act responsibly with regard to ESG perform better financially.

This burgeoning investment strategy was the focus of Barron’s first Impact Investing Summit earlier this summer, where one thing was made clear: Impact Investing is here to stay.

Seeing the opportunity to amplify their financial gains while also encouraging socially responsible corporate behavior, it’s no wonder more and more investors are adopting investment strategies that incorporate an ESG lens:

  • 70% of institutional investors say they are integrating sustainable investing into their investment process1
  • The majority of millennials, Gen X and women believe that a company’s track record in environmental, social and governance is an important consideration for investing. In fact, 37% of all high net worth investors are reviewing their portfolios for impact investments2
  • 90% of women surveyed globally said making a positive impact on society is important when considering investment decisions, and 77% indicated that they want to invest in companies with diversity in leadership3

However, while it’s just now hitting the investment mainstream, Impact Investing is not entirely new. In fact, ThirtyNorth Investments created our own Impact Investing offering, the Women Impact Strategy, more than two years ago. A carefully crafted portfolio of 50 companies with gender diversity among their corporate leadership teams, we created the Women Impact Strategy after reviewing data4 that demonstrated what we already intuitively knew: companies with more women at the top deliver excess returns.

We are proud to be counted among the individuals and organizations acting early and with conviction in the Impact Investing space, including hedge fund manager Paul Tudor Jones (whose JUST ETF, which ranks companies based on their social impact, launched this summer) and Blackrock CEO Larry Fink, who wrote to his investors earlier this year, “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”

I continue to be amazed by the breadth of companies offering new ESG funds every day. As Impact Investment options continue to grow, so too do the possibilities for making more money, and for making that money more meaningful. It is a wonderful sign of things to come.

1Sustainable Signals: Asset Owners Embrace Sustainability, Morgan Stanley Institute for Sustainable Investing  June 18, 2018

22018 Insights on Wealth and Worth, U.S Trust, 2018

3 Harnessing the Power of the Purse: Female Investors and Global Opportunities for Growth, Center for Talent Innovation, 2014

4 The CS Gender 3000: The Reward for Change, Credit Suisse Institute, September 2016

All investment strategies have the potential for profit or loss.  There are no assurances that an investor’s portfolio will match or outperform any particular benchmark.

 

July 24, 2018   By Suzanne Mestayer

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ThirtyNorth Investments Welcomes Mary Willis to the Team

We are delighted to introduce the newest member of our ThirtyNorth Investments team, Mary Willis.

Mary joins us as a Financial Associate and will focus on all investment and planning related activities, including portfolio analysis, investment monitoring, and research for our investment committee.  Mary previously served as an equity research associate at Johnson Rice & Company.  Mary’s experience included bottom-up and top-down analysis of stocks, as well as US and global macro-economic and market trends.

 

Mary earned a Masters in Energy Management from Tulane University’s Freeman School of Business.  She also obtained a B.A. in History with Honors (Energy Concentration) from Georgetown University, where she graduated Magna Cum Laude and as a member of Phi Beta Kappa.

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What are Multiple Employer Plans (MEPs)?

Multiple Employer Plans (MEPs) have been around for decades, yet, many people have never heard of this type of retirement plan.  A multiple employer plan is a plan maintained by two or more unrelated employers.  MEPs are often coordinated via a trade or business association.  For example, an MEP could be sponsored by a state dental association or a group of companies spread across the U.S. that share a common nexus, such as auto part manufacturers.

Why consider forming an MEP?

Let’s expand upon the concept of an auto manufacturer MEP.  Taking advantage of economies of scale, each auto manufacturer that adopts into the MEP shares in the benefits of its collective structure.  By pooling their investments, administration and governance structure, the MEP members could garner greater efficiencies and purchasing power. MEPs are formed to minimize costs while adding value-added services, typically offered at a premium to stand-alone retirement plans.  Just as important, plan sponsors can often minimize their fiduciary liability by participating in an MEP.

What are some of the main benefits of MEPs?

Plan Costs – By participating in an MEP, plan sponsors can potentially benefit from a reduction in:

  • Staff time and labor used to administer the plan
  • Recordkeeping costs
  • Plan audit costs
  • Investment expenses
  • Form 5500 costs
  • Plan amendment and restatement fees

Administration – Employers can outsource many of the responsibilities associated with plan administration to the MEP sponsor.  Some of these duties include:

  • Approving loans and hardship withdrawals
  • Approving distributions and qualified domestic relations orders (QDROs)
  • Plan document and operational compliance
  • Form 5500 administration
  • Plan audit, when applicable

Investments – Employers can benefit from the aggregate plan`s assets and by being able to outsource investment management responsibilities.  Some of the benefits include:

  • Investment menu selection
  • Ongoing investment monitoring
  • Access to institutionally priced investment options

Governance – Employers can outsource certain plan sponsor roles to the MEP

  • The MEP is structured to assume an administrative fiduciary role
  • The MEP is structured to assume the investment fiduciary role
  • The member company shifts its Fiduciary liability to the MEP

Though you may not have heard of an MEP, they are quite common in the corporate 401k space.  They are also gaining popularity with legislators, who want to provide coverage for small businesses (regardless of a common nexus) that are not offering employees any type of vehicle for retirement savings. These are called “open” MEPs and a timely reference is the Retirement Enhancement Security Act (RESA) of 2018. Further, we are seeing higher education organizations create MEPs that are structured as a 403(b) plan rather than a 401(k).  For example, 14 independent colleges in Virginia recently decided to create their own MEP to share in the outsourcing of education and advice, the monitoring of investments and fees, administration and fiduciary responsibilities.

MEPs come in all shapes and sizes and even offer sponsors flexibility with different plan designs. However, MEPs must adhere to certain plan qualification rules under IRC 401(a), such as with vesting, eligibility and distribution rules.  In other words, some of the rules may apply to the aggregate plan while others to the adopting plan sponsor.  Here is additional insight.

Hopefully, you now know a little more about Multiple Employer Plans and don’t confuse them with other plan types.  Quite often, people mistakenly refer to them as Multiemployer Plans, which are those created for unrelated companies covered under a collective bargaining agreement.  But, that is a whole other story.

For further information, please contact us at info@www.thirtynorth.com

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1st Quarter 2018 Market Commentary

“What a long, strange trip it’s been” – Jerry Garcia, Bob Weir, Phil Lesh, and Robert Hunter

The US stock market burst energetically out of the gate in January. Fresh off double digit gains last year, the tech heavy NASDAQ index crossed 7,000 for the first time on January 3rd. At its peak on January 26th, the S&P 500 Index was up almost 7% in the first three weeks of the year. Nine trading days later, the market entered correction territory by dropping more than 10% from that peak. The remainder of the quarter was volatile, and half of the remaining trading days saw moves greater than 1.0% in the S&P 500 Index. The S&P 500 finished the quarter down -0.76%; a long, strange trip indeed.

For the quarter, International stocks, as measured by the MSCI EAFE Index, slumped along with the US, and were down -1.04%. Emerging market stocks, however, continued their leadership. The MSCI Emerging Market Index was up 1.42%. Continuing a trend from 2017, growth stocks led value stocks amongst large, mid, small and international stocks. Interest rates rose, and bonds prices suffered. The Bloomberg Barclays US Aggregate bond index was down -1.46%. International bonds provided a lift with the hedged Citi World Government Bond index up 1.50%. REITs were hurt by the prospect of rising interest rates and were down -6.66%. Finally, commodities were mixed with the Bloomberg Commodity index closing down slightly for the quarter.

A Tale of Two Styles: Growth and Value

Market segment (index representation) as follows: Marketwide (Russell 3000 Index), Large Cap (Russell 1000 Index), Large Cap Value (Russell 1000 Value Index), Large Cap Growth (Russell 1000 Growth Index), Small Cap (Russell 2000 Index), Small Cap Value (Russell 2000 Value Index), and Small Cap Growth (Russell 2000 Growth Index). World Market Cap represented by Russell 3000 Index, MSCI World ex USA IMI Index, and MSCI Emerging Markets IMI Index. Russell 3000 Index is used as the proxy for the US market. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2018, all rights reserved. Read more

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Are We There Yet?

As we celebrate the Women Impact Strategy’s second anniversary in April, it’s a bit thrilling to reflect on all that has happened in this relatively short period of time.

We began with the seed of an idea in 2015:

If it is true that gender diversity in corporate leadership roles (directors and executives) produces better results, is there a related  investment strategy that may be both financially rewarding and socially impactful?

Our own research, in addition to that of several others[1], concluded that the investment thesis was more than wishful thinking.  The research found better stock performance over long periods of time (ten years) for public companies with higher numbers of women at the top.   But looking in the rear view mirror has its limitations, and bringing an investment strategy to life in real time is …  something else entirely.

So how is it going? Exciting on all fronts, for sure.

  • Our experience continues to support the thesis.
  • Our strategy is now available as an separately managed account on the TD Ameritrade platform
  • Articles are published daily on the benefits of diversity, and the movement of investment dollars into socially impactful investments[2] continues to grow significantly
  • We are pleased to be among a very short list of independent firms across the country that have launched a gender lens investment strategy using liquid public stocks.
  • We presented at conferences and had our research published on the Impact of Women in Corporate Leadership
  • We are encouraged by the increasing numbers of women joining public boards, and the institutional investors who announced they are voting proxies[3] with an eye on the diversity of the board member candidates.
  • Perhaps most importantly, the benefits of gender diversity across areas such as decision making, innovation, and talent retention, are becoming widely recognized as providing a strategic advantage to companies.

Like a passenger in the back seat on a long car trip, we ask the question “Are we there yet?”.  No indeed! We see progress, but we are clearly not at a defined destination.  There is no magic number which allows anyone to check a box “Done”.

For the companies in which we invest, it’s about creating and sustaining a corporate culture which values the benefits of diversity.   And that, like investing, is best done with a long term view.

Suzanne Mestayer

 

Footnotes:

[1] Credit Suisse Research Institute, “The CS Gender 3000: The Reward for Change”. September 2016, https://glg.it/assets/docs/csri-gender-3000.pdf

Hunt, V., Yee, L., Prince, S., and Dixon-Fyle, S., McKinsey & Company, “Delivering through diversity”. January 2018, https://www.mckinsey.com/business-functions/organization/our-insights/delivering-through-diversity

[2] “total US-domiciled assets unders management using SRI strategies grew to $8.72 trillion at the start of 2016”, US SIF Foudantion Biennial Reprt on: US Sustainable, Responsible and Impact Investing Trends, 2016.

[3] Vittorio, A., “New York State Pension Fund to Protest All-Male Boards”, March 21, 2018, https://www.bna.com/new-york-state-n57982090156/.

Fink, L., “Annual Letter to CEOs: A Sense of Purpose”, https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter

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The Biggest One Day Loss Ever…Really?

After the recent volatility in the market, I once again recall a few reasonable tips that help me maintain a long-term focus on investing.

 

Tip Number 1 – First, although you may be watching the “financial” news or an “investing” expert on your local news, remember they are selling news first and foremost and shock value sells.  I always remind myself to take what I hear with a grain of salt.  Don’t get me wrong, I gather valuable information from the financial media.  However, when, like on Monday, February 5th, I hear experts on the news discussing the fact that the Dow dropped the most ever in a day, I take pause.  What does that really mean?

 

Once a drop in the Dow of 250 points seemed large, but is now only a 1% move.  This may feel painful when you look at your account balance, but volatility of this nature is normal in the stock markets even if we haven’t experienced it in a while.  As Blair duQuesnay, our Chief Investment Officer, reported Monday, February 5th, the 1,175 point drop, when measured in percentage terms, was not in the top 20 historical one day moves for the Dow (https://youtu.be/me7449asL_c).  In addition, the Dow is comprised of 30 mega-cap industrial US companies.  In today’s global world, this is a narrow list of companies used to measure a much larger universe of stock investment options.

 

While the Dow is a quick proxy to the markets that is discussed prolifically, for globally diverse investors with holdings in different asset classes including bonds and alternatives, a deeper dive is prudent on these days that are characterized in the press by fear and doom.

 

Tip Number 2 – This brings me to my second tip which is that you haven’t lost money in your account unless you sell.  I often hear pundits on the news talking about how much the market lost in a day.  The correct word, in my opinion, should be the amount the market declined.  Then, it might be easier to remember that over the long-term, back to the 1920s, the market has been on a steady incline only temporarily slowed by short-term declines.

 

Yes, the value of an investment on a given day may go down or up, but it is the long-term that really matters.  Historically, on average over the long-term, the stock market has gone up delivering positive returns in spite of days that get mischaracterized as the worst down day ever.  If, in a moment of fear, you sell, then you have locked in the loss.  However, if you hold for the long-term and achieve the expected growth, you should recover the temporary decline in value and more.

 

Owning a diversified portfolio that includes investments in different asset classes all over the world can effectively help manage the volatility of a portfolio as a whole when one asset class, like stocks, is suffering a temporary decline.  I included the cartoon above hoping to make you laugh, but also because many investors feel the market ups and downs most acutely in their 401(k) accounts.  Fear raises its ugly head here almost more than anywhere because we our retirement savings are at risk.  However, taking an appropriate amount of risk in your investment accounts is paramount to achieving a successful retirement.  This is why diversification is important to control the volatility while maintaining the right level of risk in your investment strategy.  Remember, it is time in the market that matters not timing the market that is most likely to help prevent us from having to live off our belly fat in retirement.

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4th Quarter 2017 Market Commentary

Stocks around the world posted double digit returns in 2017. On the heels of a healthy 2016, the current bull market trudged along triumphantly. In a Goldilocks scenario, volatility was conspicuously absent from the markets. There were only four days that the S&P 500 Index declined more than 1%, with the largest drawdown of 1.82% occurring on May 17th. Emerging markets saw the strongest returns with the MSCI Emerging Markets Index up 37.28% for the year. No, that’s not a typo.

Bond returns were more muted with the Barclays US Aggregate Bond Index finishing the year up 3.54%. International and emerging market bonds also outpaced returns on domestic bonds, aided by a weaker US dollar. Short-term interest rates continued to rise, while long-term rates held steady. The 2 Year Treasury began the year at 1.20% and finished at 1.89% while the 10-Year Treasury barely budged from 2.45% to 2.40%. Oil seemed to break out of the $45 – $55 range it has traded in since mid 2016. West Texas Intermediate (WTI) finished the year at $60.46 per barrel.

Tax Overhaul

On December 22, President Trump signed into law the Tax Cut and Jobs Act of 2017. While the law makes many tweaks to individual taxes, the major changes affect US corporations. The maximum corporate tax rate of 35% drops to a flat rate of 21%. This is combined with the elimination of the alternative minimum tax (AMT) for corporations. Sadly, the AMT elimination for individuals was scrapped in conference negotiations, but the threshold for qualifying for AMT jumps to $500,000 for individuals and $1,000,000 for married couples.[1] In addition to lowering the corporate tax rate, the law allows corporations to bring back cash from overseas and pay a one-time 15.5% repatriation tax rate. This could be a potential boon for the tech industry, as Apple, Microsoft, Cisco Systems, and Google (Alphabet) have $483 billion in cash parked overseas.[2]

Most investors speculate that smaller companies, that conduct most of their business domestically, will benefit the most from the tax changes. However, companies carrying deferred tax assets on their balance sheet will have to recognize a reduction in value of that asset. Further, limits to the deductibility of interest could hinder companies with large amounts of debt.[3] Corporations lauded the changes, with many well-known names announcing one-time bonuses, minimum wage hikes, or increased 401(k) matching for their employees. More time is needed to digest the final implications of the tax changes. Companies reporting year-end earnings will offer the next clues.

Market Valuations

Since the low in March 2009, the S&P 500 Index is up over 430% on a cumulative, total return basis. Investors seem nervous that the market is being overvalued. There are many metrics for attempting to quantify whether or not the market is over or undervalued. Each metric has its merits and each has its flaws. The forward price-earnings (P/E) ratio of the S&P 500 Index is 18.2 times earnings. This is higher than the 25-year average of 16.0 times earnings but below the 1999 peak of more than 24 times earnings. The Shiller price-earnings ratio (CAPE) is currently 32.4, well above the 25-year average of 26.4. The price-to-book ratio (P/B), a more stable valuation measure, is currently 3.1 for the S&P 500 Index versus a 25-year average of 2.9.[4] By all measures, the market value is higher than historical average but not approaching any records.

One crucial factor in considering price-earnings ratios is the denominator, earnings. Third quarter 2017 earnings for the S&P 500 Index were $31.32 per share, an all-time record.[5] Consensus analyst estimates call for the next four quarters of earnings to break this record. If earnings are growing, future projections for PE ratios may not be as rich as predicted. While short-term distractions such as politics, geopolitical tensions, commodity booms and busts, natural disasters, and war move markets in the short-run, the underlying factor for valuation of stocks is corporate earnings. From this perspective, the growth in the markets seems reasonable.

The S&P 500 Index has reached 188 new all-time highs since March 2013. There were 61 new all-time highs in 2017 alone. This statistic tends to make investors nervous. However, historically the stock market has made many new highs to get to today. Try to remember your experience investing during the 1980’s and 90’s. Dare we hope to be in the midst of a similar experience?

Bitcoin

Cryptocurrencies and Bitcoin dominated the financial news cycle when the price of one Bitcoin turned parabolic and climbed to more than $19,000. Let me preface this segment by saying that we have no expertise in cryptocurrencies and understand them only slightly better than the average person. However, the topic is now commonly broached in our client meetings and conversations. What we know is that the technology underlying cryptocurrencies, known as blockchain, could lead to extraordinary advances in the ease of transacting in financial markets. This has led large financial firms such as Fidelity Investments and Goldman Sachs to invest in research for the application of blockchain in financial transactions.

Before you are tempted to download the Coinbase app and start trading Bitcoin, Ethereum, or Litecoin, consider that these instruments lack some of the most basic protections to be considered “investments”. For example, there is no method of custody for cryptocurrencies. A custodian is a financial institution that holds investment assets in safe keeping and communicates the value of your holdings via regular statements. Further, the IRS issued guidance in March 2014, that cryptocurrencies are considered property and subject to taxation when received as income or as a result of a capital gain or loss. However, with no custodian to issue the appropriate tax reporting, investors have no mechanism to prove their cost basis if audited by the IRS. If you want to take a deep dive into the abyss of cryptocurrencies, Patrick O’Shaughnessy interviewed some of the leaders in the field over three episodes of a podcast titled Hash Power.

Everyone’s favorite investor Warren Buffett recently weighed in on the Bitcoin craze saying; “In terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending.” Bitcoin is already down almost 40% from its December peak. It’s likely there will be many booms and busts as this technology, currency, dare we say “asset class” approaches maturity.

Fear and Greed

Despite all the statistics and fancy analysis we have today, the markets are a derivative of human emotion. Numerous studies prove that humans fail to act on logic and reason when money is involved in the decision making; especially if losing money is a possibility. There’s a great book detailing the history of market hysteria and bubbles beginning with the Tulip Mania in Holland in the 17th century. Extraordinary Popular Delusions and the Madness of Crowds is a fascinating but dense study of human greed and the “fear of missing out”. I suspect there’s a little of this happening with Bitcoin lately. In hindsight, there are always extraordinary investment options that could have been life changing. One of my favorites is holding Apple stock since it became public in 1980. But is there even one investor who managed to own it for the entire time-period? Everything looks easy in hindsight. Investors should keep their heads down, follow a disciplined strategy, rebalance periodically, and let time pass.

Remember these two? Tweedledum and Tweedledee are a great analogy for fear and greed. Both emotions are equally dangerous for investors.

 

January 2018

 

Footnotes:

[1] Kitces, M. “Individual Tax Planning Under the Tax Cuts and Jobs Act of 2017”. December, 18, 2017. https://www.kitces.com/blog/final-gop-tax-plan-summary-tcja-2017-individual-tax-brackets-pass-through-strategies/

[2] Meisler, L. “The 50 Largest Stashes of Cash Companies Keep Overseas”. June, 13, 2017. https://www.bloomberg.com/graphics/2017-overseas-profits/

[3] Blomberg BNA, Tax Reform Watch; https://www.bna.com/2017-corporate-tax/

[4] JPMorgan Q1 2018: Guide to the Markets, slide 5, https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets

[5] JPMorgan Q1 2018: Guide to the Markets, slide 7, https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets

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