Q3 Market Commentary: Excellent, But Vulnerable Markets With all the risks today, are investors complacent?

By Paul Hoffmeister

It is our belief that 2017 has been a rewarding year for most investors. Through the third

quarter, the S&P 500 is up nearly 13% and the Nasdaq 23%, while the Barclays

Aggregate U.S. Bond Index has returned almost 3%. Even more, in July, stock market

volatility was the lowest in the last 10 years.

 

Investment returns appear to have been strong, and markets are calm.

We believe the primary factors behind this sanguine environment are the prospects of

tax reform and a Fed policy approach that, at least for this year, has been looking to “do

no harm”.

 

By all appearances, the Federal Reserve seems to be implementing policy more

reactively than proactively. In other words, the FOMC has been only raising interest

rates to a degree that we believe won’t agitate financial markets.

And in Congress, the House has passed a tax reform bill whose primary aim is to

reduce the corporate tax rate from 35% to 20%, in addition to providing some individual

tax relief. Holding all other variables constant, the 15 percentage point reduction in the

statutory corporate tax rate should increase corporate earnings up to 23.1%. If market

multiples hold, this tax reduction should theoretically correlate with an equivalent

increase in stock prices. Perhaps not coincidentally, the S&P 500 has rallied nearly 20%

since Election Day.

2nd Quarter Market Commentary 2017

AdobeStock_66932407.jpeg

Caution is Warranted

BY DARREN MUNN, CFA

For those who are parents, you know the feeling when you realize the house is quiet.  Too quiet.  You have been enjoying the peace and calm, but realize something is not right.  You want to believe it is because your children are angels and are playing nicely in their rooms, but your gut tells you that is not the case.  You go to explore and find your children have gotten into your lipstick and drawn all over the walls, or tried to baptize the cat in the toilet, or found your chocolate stash and decided to save you from all those unnecessary calories.  We have all heard of other cases where the result is more sinister, resulting in harm to the children. 

As a nearly 20 year investing veteran, I am having one of those moments now.  It is more than just a gut feeling – there are many indicators we follow that lend support to the notion that something is not right in the markets.  Things are calm and appear to be well, but under the surface, trouble may be brewing.  I believe the risk in the market at this point is quite elevated and any further gains experienced in the short term will likely be reversed when the market experiences some volatility. 

Is this a certainty?  Absolutely not – it is possible the market could keep chugging higher for quite some time.  However, I believe that is a low probability scenario.  I believe a more likely scenario is that we experience a 5-10% pullback in the market before the end of the year, wiping out about half of the gains since the election.  I don’t believe this is a “Johnny cut off his hand” scenario.  It is more like a “Johnny decided it would be fun to jump off the garage and broke his leg” scenario.  It will cause some pain in the short term, but will not cause permanent damage to a well-designed investment plan.

In reality, I believe it will create some great investing opportunities for us – we just have to be patient and disciplined to capitalize on them.  We have continued to raise or accumulate cash in many of our strategies so we have dry powder to take advantage of these opportunities for our clients.   

The second quarter was essentially a continuation of what we observed in the first quarter: market gains driven by a small number of stocks, unexciting economic growth, no progress on tax reform or health care reform, and the Federal Reserve raised interest rates another .25% in June.  

Geopolitical concerns continue to fester, but have not rattled the market.  Corporate profits showed strong growth in the 1st quarter (as expected) but likely grew at a slower pace in the 2nd quarter. 

As previously mentioned, last quarter the gains in the market were largely being driven by a small number of stock.  For example, from March 1, 2017 to July 31, 2017, one stock (Boeing) accounted for about half of the gain on the Dow Jones Industrial Average.  If you throw in one more stock (McDonalds), together they account for nearly 75% of the gains, meaning the other 28 stocks in the index only accounted for 25% of the gains. (Morningstar)

Positives

  • Employment continued to be steady with the unemployment rate at 4.4% in June. (U.S. DOL)

  • Low oil & gas prices continue to save money for consumers, but the savings have been shrinking.

  • We believe energy markets have stabilized and are near equilibrium.  We expect oil to stay in the $40-$60 range for the foreseeable future.

  • Housing has continued moderate--but choppy--growth.  Low interest rates have helped keep prices affordable.  (Barron’s)

  • Economic growth continued in the first quarter, but was very weak at 1.2%.    Initial readings for the 2nd quarter suggest a much better growth of 2.6%, following a similar patter we have seen over the last few years.

Challenges & Risks

  • Economic growth will likely trend in the 2% range in our opinion.

  •  Interest rates – the Federal Reserve raised interest rates again in June and expects at least one more increase this year.  In addition, they intend to start shrinking their balance sheet.  This is something that has never happened before and is a major factor in our concerns about the markets.

  • Government regulation is a potential huge drag.  Health care costs are continuing to rise significantly & government interference in several areas (finance, education, energy) continue to limit economic growth.  Will this improve in 2017? 

  • China, Europe, North Korea, & Russia – They have certainly been capturing headlines as expected, with more to come. 

Despite the concerns heighted above, we believe there is still a high likelihood of decent investment returns in the coming years.  We simply wanted to highlight some likely short-term concerns which explains why we have built larger than normal cash positions in some strategies. 

We will continue to monitor these developments closely and seek to use them to your advantage.  This is our mission!  Have a great summer!

Sources:

1)      Bloomberg

2)      Barron’s

Disclosures:

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.  This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client.  These materials are not intended as any form of substitute for individualized investment advice.  The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own.  Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors.  Camelot Portfolios LLC can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein. A486

1st Quarter Market Commentary

Waiting for Proof

BY DARREN MUNN, CFA

What a difference a year makes!  While 2016 started with a large drop in the equity markets, 2017 started with a continuation of the market gains experienced after the election with very little interruption.  Yet, we still have not seen any progress on the tax reform or health care reform, which many (including me) believe are the primary drivers in moving the market higher over the last several months.  The healthy skepticism we expressed last quarter remains and time is likely running short for results to happen before the market loses patience.  

Based on the data we have seen so far, it doesn’t appear the economy has accelerated like many expected.  The Federal Reserve raised rates another .25% in March and expects two more increases this year, but we continue to expect moderate & sluggish economic growth, which will make that third increase very difficult.  The market seems to be agreeing with us now as the 10-yr bond yield has dropped quite a bit since the rate increase in March.  

To top it off, there have been significant headlines in Europe, China, North Korea, and now Syria – none of which have seemed to faze the market.  Corporate profits are expected to be significantly higher for Q1 2017 than a year ago, which seems to be the focus of the markets (rightfully so).  Oil has been relatively stable and energy companies are starting to show some profits, which is a significant turnaround from last year.

The S&P 500 and Dow Jones Industrial Average experienced strong returns in the first quarter and bonds experienced some small gains, as 10-year yields moved down slightly for the quarter.  But underlying these numbers, the overall market was actually experiencing some turmoil as select parts of the market are actually down for the year.  We could probably dust off a commentary from several quarters ago as the positive returns on the S&P 500 are being driven by a small number of very large companies, creating a false perception that everything is rosy.

We are not fooled, nor are we worried.  But we are cautious and expect to have some better buying opportunities in the near future, allowing us to deploy some of the dry powder we have accumulated in many of our strategies.

Positives

  • Employment continued to be steady with the unemployment rate at 4.5% in March. (U.S. DOL)
  • Low oil & gas prices continue to save money for consumers, but the savings have been shrinking.
  • We believe energy markets have stabilized and are near equilibrium.  We expect oil to stay in the $40-$60 range in 2017.
  • Housing has continued moderate--but choppy--growth.  Low interest rates have helped keep prices affordable.  (Barron’s)
  • Economic growth continued in the fourth quarter, but dropped to just 2.1% as we expected.

Challenges & Risks

  • Economic growth will likely trend in the 2% range in our opinion.
  •  Interest rates – the Federal Reserve raised interest rates again in March and expects 3-4 increases this year.  We believe this is more than the economy can handle and believe it should only raise twice.
  • Government regulation is a potential huge drag.  Health care costs are continuing to rise significantly & government interference in several areas (finance, education, energy) continue to limit economic growth.  Will this improve in 2017? 
  • China, Europe, North Korea – we expect these three to capture significant headlines in the coming year.  
  • Oh, let’s add Russia to this list!

While we have certainly enjoyed the positive run in the market these last two quarters, we know the market will experience some volatility at some point.  Trying to time that is futile.  Instead, we have sold some positions due to high valuations and are sitting on some more conservative holdings to take advantage when the market creates buying opportunities.  

We consider ourselves very blessed to serve you and hope your 2017 is off to a great start!


Sources:

1) Bloomberg

2) Barron’s

Disclosures:

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.  This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client.  These materials are not intended as any form of substitute for individualized investment advice.  The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own.  Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors.  Camelot Portfolios LLC can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.  A401

4th Quarter Market Commentary

Election Aftermath

By Darren Munn, CFA

Aren’t you glad that’s over!  This election season was brutal.  For several months, there was no escaping it.  It dominated the headlines, both in the mainstream media and on social media.  The same was largely true in the financial markets, which were closely watching the election.  The ultimate outcome, a Trump victory and Republican sweep of congress, was considered a huge surprise and sent the markets into a tailspin…for all of about 10 hours.  In the evening of the election, stock futures dropped 5% before being shut down for the night as it became apparent Trump would win.  But by the time the markets opened the next day, stock futures had completely recovered and stocks ended the day 1% higher!1 

The small gains we anticipated when a clear winner emerged turned into fairly large gains, as the S&P 500 surged about 6% after Election Day through the end of the year.1 Why? In a nutshell, we believe the market is expecting a stronger economy with Trump as president.  This will largely be driven by lower corporate tax rates, which directly translate into higher profits, which means higher stock prices.  Of course, this is all before Trump is even in office or any legislation has been passed – so it appears to us the market is pretty confident about the likelihood of these developments. 

We agree with the markets that a Trump presidency is more favorable for the economy…BUT.  That is a big “but”.  There are certain factors in play over which Trump will have no control, so how much impact he will have remains up for debate.  The Federal Reserve raised interest rates again in December and indicated they expect several more increases in 2017.  Sound familiar?  We believe this and the strong dollar will be headwinds, in addition to some other concerns we have been watching.  The reality is, we may be headed for a recession in the next year or two regardless of what Trump does.  If so, we believe it will be a shallower recession than it otherwise would have been. 

The fourth quarter was again positive for stocks and easily the worst for bonds – which gave up much of their gains for the year as rising interest rates drove down bond prices.  Most of the positive move for stocks and negative move for bonds came after the election.  (Morningstar)

Positives

  • Employment continued to be steady with the unemployment rate at 4.7% in December. (U.S. DOL)
  • Low oil & gas prices continue to save money for consumers, but the savings have been shrinking.
  • We believe energy markets have stabilized and are near equilibrium.  We expect oil to stay in the $40-$60 range in 2017.
  • Housing has continued moderate--but choppy--growth.  Low interest rates have helped keep prices affordable.  (Barron’s)
  • Economic growth picked up in the third quarter to 3.5%2 - but we do not expect this rate to continue.

Challenges & Risks

  • Economic growth will likely trend in the 2% range in our opinion.
  • Oil price declines are still working through the system and we are seeing the expected defaults from many energy companies. 
  •  Interest rates – the Federal Reserve raised interest rates in December and expects 3-4 increases next year.  We believe this is more than the economy can handle and expect only 1-2 increases next year.
  • Government regulation is a potential huge drag.  Health care costs are continuing to rise significantly & government interference in several areas (finance, education, energy) continue to limit economic growth.  Will this improve in 2017? 
  • China, Europe, North Korea – we expect these three to capture significant headlines in the coming year.

Despite a rocky start, we believe 2016 turned out to be a pretty decent year in the markets.  Unfortunately, investors who panicked during the rocky period of January and February seemingly missed out on some very substantial returns.  We have been working to “lock in” some of our gains and move capital to investments we believe offer greater upside potential over the next few years. 

We are excited about what 2017 has in store and are honored to serve you!

Sources:

1)      Bloomberg

2)      Barron’s

Disclosures:

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.  This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client.  These materials are not intended as any form of substitute for individualized investment advice.  The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own.  Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors.  Camelot Portfolios LLC can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein. A33

3rd Quarter Market Commentary

Brexit, Zika, Election, Oh My!

By Darren Munn, CFA

This quarter is a perfect example of how the market, and society in general, jumps from one fear to the next.  The vast majority of the time, the fears come and go with little lasting effect.  The end of the 2nd quarter ended with a bout of volatility over Brexit fears.  As the third quarter started in July, the market bounced right back and now Brexit is hardly mentioned anymore.  Then, with the Olympics in August, the Zika virus became a hot topic with fears of worldwide outbreaks.  Yet not a single athlete contracted the virus.  Now, attention has turned to the election and the fears of what will happen when the results come in.  Yet the market continues to be resilient in the face of the fears.  As the old adage goes, “the market climbs a wall of worry.”  

Many clients are asking about the impact of the election.  In our last letter, we discussed how the market hates uncertainty.  In the short term, until there is a certain and clear winner, both for president and congress, the market will probably bounce around with little progress.  Once there is certainty about our next slate of leaders, I believe the market will likely celebrate with some small gains, regardless of who is elected.  

Longer term, I don’t believe the President has as much impact as many believe, but there is certainly impact.  The result of the election will affect our expectations for future economic growth, which will influence how the markets do over the next 5-10 years.  But this impact will likely only be marginal.

The third quarter was the best of the year for stocks and the worst for bonds – both of which have done reasonably well for the year.  For both stocks and bonds, nearly all of the return for the third quarter came in July, with essentially flat markets in August and September.  

Positives

  • Employment continued to be steady with the unemployment rate at 4.9% and job openings increased to 5.8 million.
  • Low oil & gas prices continue to save money for consumers.
  • Oil & gas rig counts have continued increasing over the last few months, which is helping to stabilize the energy sector of the economy.
  • Housing has continued moderate--but choppy--growth.  Low interest rates have helped keep prices affordable.

Challenges & Risks

  • Economic growth has been very sluggish: Q1 = .8%, Q2 = 1.4%
  • Oil price declines are still working through the system and we are seeing the expected defaults from many energy companies.  
  • Oil dipped during the quarter, but came right back to the $50 range.  So we got to enjoy some nice gas prices a little bit longer.  But the end of sub-$2.00 gas is likely upon us.
  • Interest rates – the Federal Reserve still did not raise interest rates in September and now only expects one increase for the year.  The uncertainly has affected the markets and they seem to have painted themselves into a corner for a December rate hike just like last year.
  • Government regulation is a huge drag.  Health care costs are continuing to rise significantly & government interference in several areas (finance, education, energy) continue to limit economic growth.

Frankly, we are pleasantly surprised with how well the market has done this year considering the weak economic growth and uncertainty surrounding the election.  Times like these reinforce the proven wisdom of diversification and not trying to time or predict the market.

2nd Quarter – 2016 Market Review Letter – What’s a Brexit & Why Does it Matter?

Just three months later, the pain and anguish of the first quarter seem like a distant memory.  The recovery that started in mid-February continued through the second quarter, with parts of the stock market ending the quarter near record highs and bond yields near record lows.  

But the last couple weeks of the quarter brought the greatest volatility as the people of Britain voted to leave the European Union, a surprise result.  Thus, the “Brexit” has been dominating recent headlines.  While Britain leaving the EU is likely to be positive for Britain (in our opinion), the uncertainty created by this move rattled the markets and more volatility is likely as the details of the exit are negotiated.  It also opens the door for other countries to leave the EU, which could lead to the unraveling of the entire arrangement and even more uncertainty.

Predictions regarding the ramifications of Brexit are all across the spectrum, from utter collapse of the British Empire and EU to positive ramifications of new economic freedoms & less restriction.  

The fact is, the market hates uncertainty.  Uncertainty is to the market what kryptonite is to Superman.  Even if none of the likely potential outcomes are particularly bad, the market still panics in the face of uncertainty.  Even if the likely potential outcome is bad, the market loves the certainty.  But the reality for long-term investors is not all uncertainty is bad.  In fact, some of it is very good, especially when it gives us great investing opportunities.  

Positives

  • Employment continued to be steady with the unemployment rate dipping below 5% even though job growth has slowed the last few months.
  • Low oil & gas prices continue to save money for consumers.
  • Oil & gas rig counts have been increasing over the last few weeks, which will help jobs numbers if the increase continues.
  • Housing has continued moderate but choppy growth.  There still seems to be plenty of pent-up demand.

Challenges & Risks

  • Oil prices declines are still working through the system and we are seeing the expected defaults from many energy companies.  
  • Oil continued its rise, hitting over $50 in recent weeks.  This likely spells the end of sub-$2.00 gas in the near future.
  • Interest rates – the Federal Reserve still did not raise interest rates in June and now only expects one or two increases for the year.  Either way, it is uncertainty for the market.
  • Corporate earnings have been weaker than expected & tough weather is not a good excuse this year.

The first half of the year has been quite the roller coaster ride.  We believe this volatility is actually more “normal” than what we have experienced over the last several years and is likely here to stay.  

As Peter Lynch said, “A stock market decline is as routine as a January blizzard in Colorado.  If you’re prepared, it can’t hurt you.  A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.”  A239

4th Quarter – 2015 Market Review Letter – Prudent Decisions in the Face of Panic!

Fourth Quarter Market Commentary

“I can’t take much more it this!”  We know this is the common sentiment shared by many investors at this point.  The volatility that started in the second quarter and worsened in the third quarter continued through the fourth quarter then made a dramatic jump to start 2016, making it the worst first week of a calendar year on record.  The frustrations that grew over the last year are leading many investors to want to throw in the towel.  We understand these feelings – they are normal and natural.

We also know from history how detrimental these emotions and the natural responses are to investors, causing them to make the wrong decision at the wrong time, which normally leads to missing out on much of the returns offered by good investments.  In fact, investment analysts consider the massive outflow of money from stocks over the last few months to be a positive future indicator for stocks because of the poor track record of market timers.

I have been managing investment for about 18 years now and have seen this type of environment several times.  It is scary!  It is disheartening!  It is downright depressing!  Those feelings are normal – I have them too.  I lose sleep…a lot of it, so you don’t have to.  But the key to successful investing is to ignore those feelings; don’t make decisions based on market movements or short-term performance, but instead focus on the fundamentals.  This has been a major part of our historical success – taking advantage of the crazy times—and is based on the strategies of highly successful investors who have gone before:

    “Investors make money in a bear market; they just don’t know it at the time.” – Shelby Davis

    “If you stay rational yourself, the stupidity of the world helps you.” – Charlie Munger

    “Be greedy when others are fearful.” – Warren Buffet

2015 Recap

Stocks – While the major market indexes (S&P 500, Dow) were just barely positive for the year, several broader market averages (NYSE Composite, Russell 2000) were down 5-10% or more.  This shows the underlying weakness & divergence we have discussed in past commentaries.  In fact, by 1/5/16 the average stock in the major indices was down 24% from their 2015 high (Bespoke Investment Group).

Bonds – Interest rates ended the year slightly higher than where they started, with the 10 year treasury at 2.27%.  As a result, bond returns were essentially flat with the Barclays US Aggregate Bond index up just .55% for the year.  But just like stocks, many parts of the bond market were down 2-5% or more.

Not much changed from our Q3 commentary as the two-faced market continued, as did the moderate economic growth we expected.  Volatility increased as oil continued to drop.  At this point, many parts of the market look like extreme opportunities, like we have not seen since 2008-2009.  

Positives – 

  • The unemployment rate dropped to 5.0% as job growth ended the year strongly.
  • Plunging oil & gas prices continue to save money for consumers.
  • Interest rates – stayed relatively stable for the year despite expectations for significant increases.
  • Housing construction resumed moderate growth and is expected to continue.

Challenges & Risks

  • Oil prices continued to fall, which will lead to further job losses in that sector and more bond defaults.
  • Interest rates – the Federal Reserve finally raised interest rates in December and laid out their expectations for rising rates over the next few years.  We believe they are overly optimistic and will not raise rates near as fast as expected.
  • Health Care – premium increases continued and will hit many consumers in the beginning of 2016.
  • China – Their growth rate is in question, with fears of greater slowing spooking the markets.
  • Russia, ISIS, North Korea, Iran – nothing changed here, probably won’t for a while.

Already in 2016 a lot has happened.  We are working on further commentary and videos to help keep you informed in a timelier manner.  We know this commentary is overly-simplified and want to provide more detail of what we are seeing to those who are interested.  We will begin delivering video updates via our email newsletter in 2016.  Please contact jamiemoan@munnwealth.com if you are not subscribed.  1323ASM