We’ve Had A Selloff, Now What Do We Do?

In December, both US and international stocks have experienced a significant sell off.  The S&P 500 has now declined approximately 20% (peak to trough) from all-time highs set in September.

Many investors are left wondering what to do now. It’s perfectly normal to have questions and concerns when markets have severe downturns.  When making decisions after market sell-offs, it’s important to control emotions and avoid panic movements you may regret later.  In that regard, here are suggestions we have regarding the current situation and what investors can think about:

  1. Understand that this happens in the stock markets. According to Sam Stovall, Chief Investment Strategist for CFRA, the S&P 500 has had 22 corrections (defined as 10% down from recent highs) and 12 bear markets (defined as 20% down from recent highs) since 1945.  While never enjoyable, these events are relatively common in the markets.  Over longer periods, however, stocks remain the best source of growth for portfolios. 
  2. Understand the purpose of the different assets in your household portfolio. At Gradient, we strive to diversify client portfolios in accordance with their individual risk and return objectives.  What this means is that we utilize assets that are relatively safe (bonds, cash, annuities) in conjunction with more growth-oriented assets (stocks) to provide a diversified financial plan that meets your risk and return objectives.  When stocks are increasing rapidly, investors tend to wonder why they own assets that aren’t growing as fast.  When stocks are falling rapidly, investors tend to wonder why they have stocks in the market at all.  By understanding the purpose of the investments in your portfolio, it provides greater clarity on your financial plan on how those assets work together to meet your objectives.
  3. Rebalance and make moves at the margin. If you feel the need to “do something” as a result of changes in the market, it is always better to make moves at the margin rather than making “all-in” or “all-out” transactions.  Timing the market is incredibly difficult to do and is typically a detractor of value over time.  However, an action that can add value is periodic rebalancing.  As markets rise and fall, current allocation weightings can change from their original long-term allocations.  Periodic rebalancing allows investors to sell stocks after a sharp rise or buy stocks after a significant decline. This realigns portfolios back to their appropriate percentage allocations in accordance with your financial plan.
  4. At Gradient Investments we understand that during sell-offs investors often tend to throw out the baby (good companies) with the bath water. We use this situation opportunistically to realign our portfolios internally. During the decline we have been scouring each portfolio’s investable universe for opportunities as valuations get cheaper for companies that are high quality and have sustainable long-term growth profiles.  We transition stocks within portfolios to take advantage of those opportunities. We also aim to rebalance not only our allocation portfolios, but also the stock portfolios as prices bottom out.

In our opinion, investors fare better having a long-term financial plan that incorporates several asset classes to meet their objectives.  Diversification works over time, but doesn’t work all the time.  Understanding how assets work together in your overall financial plan can shield investors from making decisions based on emotion. This gives them a better chance of achieving their long-term objectives.

To reiterate our stance from early December, we believe:

  • 2019 is a slowing growth, but not recessionary, economy.
  • Consumers remain relatively healthy and are spending
  • Corporate earnings growth will slow from 2018, but should still have mid-single digit growth in 2019
  • Valuations are more attractive now than they were 3 months ago

In summary, market declines are normal but still difficult to deal with. A diversified financial plan (including both safe and growth assets) can provide less volatility over time while still helping achieve long-term goals. Before making portfolio decisions please talk to your advisor to get an objective opinion on the situation. Finally, keep in mind that our economic forecast is still constructive, and after the recent pullback we feel the prospects for positive market returns in 2019 are strong.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on January 2, 2019 Read More

October Correction

Global markets have been under pressure so far in October. In fact, there really hasn’t been any safe-haven around the world except cash. Let’s look at the returns of the last 4 weeks and year-to-date (YTD) as of 10/26/2018 in various markets around the world*:

Those type of returns around the globe are alarming. Especially when things seem to be doing well in the US economy and corporate America. Isn’t US GDP growth quite strong, unemployment at record lows and corporate earnings growth strong? They are, so what is causing investors so much anxiety these days? I’ve explored several reasons why investors might be selling below:

The Federal Reserve has been raising interest rates. So far in 2018 there have been 3 rate hikes with the Fed telegraphing one more in December. Concerns abound that the Fed will raise rates too fast and spur on an economic recession. The benchmark 10-year treasury is now over 3%, a level it hasn’t seen since December of 2013. See chart below**:

In reaction to higher rates, homebuilding and auto industries are showing some slowdowns. These are important industries in the US. Will this continue? See charts below:

Inflation also has investors concerned. Full employment can lead to wages growing and a strong economy can lead to higher costs both for consumers and corporations. Inflation is now above the 2% level which is the Fed’s longer-term target. See chart below**:

The tariff wars the US is having with other countries is also causing investor angst. So far, the tariffs that have been imposed have not slowed down the economy. But if the trade war continues there is the potential for it to negatively impact the economy. The below chart reflects the possible negative impact a tariff war could produce on our economy’s GDP growth:

Finally, there seems to be some concern that the US economy and corporate earnings growth has peaked and will incrementally look less robust in 2019. There is some merit to this as earnings growth in 2019 is forecast around 10% yr/yr (versus roughly 20.5% in 2018)*** and it will be hard for the US economy to continuously produce 3-4% GDP growth every year.

In summary, investors are concerned about rising interest rates, inflation, tariffs and a peaking US economy. In addition, we are now in 3rd quarter corporate earnings reporting season and many CEOs are mentioning that inflation and tariffs have the potential to hurt their profits going forward. All of this has led to the market pulling back despite what seems to be a constructive environment for stocks.

Is this just another correction in the stock market that happens all the time? Or is this the end of the long bull market and the start of a bear market? We don’t have a crystal ball, but we feel this is an overdue correction and not a crash. We don’t see the economy slipping into a recession anytime soon. Remember corrections (periods of 10-20% declines) are much more frequent than bear markets. In fact, since 1974 of the 22 corrections that have taken place only 4 have turned into bear markets. See the chart below****:

Stock markets look forward, and right now the concern is about future growth being negatively affected by interest rates, tariffs, inflation, etc. In times like these it helps to keep an eye on the longer-term and ask yourself if you are correctly allocated between stocks and bonds. Also, look back and see if your financial goals and objectives are on track. If they are, stay the course. Don’t let the emotional halo of a correction drive you into decisions you may regret.

*Morningstar, Inc Index Performance: Return (%)

**Economic Research, Federal Reserve Bank of St. Louis

***FactSet, Earnings Insight, October 26th, 2018

****Schwab Center for Financial Research with data provided by Morningstar, Inc. The market is represented by the S&P 500 index.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on October 30, 2018 Read More

Third Quarter Market Review

The third quarter is history and markets are standing tall despite warnings of seasonal weakness and further trade concerns.  U.S. stocks, led by the red hot growth sector, set two records this quarter.  This is now the longest running bull market ever and major indices achieved all-time record levels in September.  Growth has been an important factor as U.S. GDP growth hit 4.2% in the second quarter.  Supportive fiscal policy, confident consumers, strong corporate earnings and low interest rates may likely keep momentum positive through year end.

The Federal Reserve is sticking to their well-telegraphed game plan of gradually raising short-term interest rates 25 basis points per quarter. The September move marks the fourth consecutive quarterly rate hike bringing the targeted Fed funds rate to 2.00-2.25%.  The journey to a normalized monetary policy is underway as the Fed simultaneously tries to shrink their balance sheet while raising short-term interest rates.  The Fed needs to get all their tools back in the tool box before the next economic downturn hits.  So far so good, but they will need years to completely finish the job as the balance sheet reduction project is in its infancy.

Trade and trade agreements are still a hot potato for the markets.  Despite all the facts, tweets, and opinions, the market is taking much of this uncertainty in stride.  President Trump announced a preliminary agreement with Mexico to modernize NAFTA and the market applauded.  Even Canada joined at the very last minute.  China and the U.S. continue to up the tariff ante. While the end game is unknown, it appears ramping up the rhetoric and action is becoming less of a market negative.  A final trading agreement between the two economic powerhouses may well prove to be a future bullish catalyst for stocks.

The strong U.S. dollar, along with trade tariffs, have taken their toll on the foreign markets.  To date, the U.S. stocks have fared much better than both international and emerging markets.  The Dow Jones Industrial Average was the lead dog in the third quarter gaining 9.63% while setting an all-time high.  The S&P 500 and the NASDAQ composite also had a strong quarter gaining 7.71% and 7.41% respectively.  The two major international indices (MSCI Emerging Markets and MSCI EAFE) were mixed for the quarter at -1.09% and +1.35% respectively.  Growth stocks are still outperforming value stocks around the globe.

The bond market is dealing with multiple cross currents, but the tide is taking interest rates marginally higher, causing prices to decline.  The benchmark 10-Year U.S. Treasury spent most of the quarter yielding just below three percent but ended the period yielding 3.05%, up 20 basis points in the quarter. The yield curve continued to flatten, as the 2-Year Treasury rose by 29 basis points to end the quarter yielding 2.81%, and the 30-Year Treasury rose 21 basis points to yield 3.19%.  Someday bonds will once again offer value.  Until then, own short duration bonds for liquidity and portfolio risk control.

Portfolio diversification is the most important tool to achieve your long-term financial goals.  We diversify to manage risk and protect against unwanted volatility.  Short-term market moves can entice investors to abandon a well-diversified approach at exactly the worst time.  The record rally into quarter end raises questions better left unasked.  Questions like, “why do I own bonds?”, “why do I have a cash position?”, “why do I own international stocks?”, and “why don’t I have all my money in Amazon and Apple?”  The correct answer is diversification.  Protecting your nest egg through diversification does not need an apology.  U.S. growth stocks are currently the best place to be, but leadership rotates over time.  The right asset allocation allows your portfolio to weather all storms and will keep you invested for the long haul.

MARKETS BY THE NUMBERS:

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on October 1, 2018 Read More
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