Stewardship

Last month, Morgan Arford titled his newsletter “Greed is (Not) Good”, in which he analyzed current market sentiments and the fear that retail investors have about missing out on a Bull Market. He pointed out that in the late stages of a market cycle, “Investors start to become less concerned with whether their portfolios are providing the returns they need, and more about whether their assets are ‘keeping up’ with other potential investments.”

Morgan’s newsletter on January 24 was incredibly timely, as the beginning of February saw the largest drawdown in the stock market in over a year, triggered by rising interest rates, anxiousness about inflation and high-frequency trading software.

In order to effectively manage money and achieve long-term success, we need disciplined emotional intelligence. We need to be aware of our own biases, perceptions, limitations and ego. The flaw in money management is thinking that it’s possible to know every aspect of the market, the magnitude of each detail and the timeline that any given event may unfold. This is why the markets can be so frustrating at times when expectations don’t meet reality.

As Financial Planners and Money Managers, our clients entrust us with the responsibility to develop investment strategies that enable them to take appropriate market risk in order to work toward their long-term goals in life. The goal of our investment process is not to “beat the market”. The goal of our approach is to provide clients with a risk-adjusted investment strategy that focuses on long-term success rather than riding the rollercoaster of a stock market, and blindly hoping that your future plans coincide with the economy.

Professor Jean-Paul Rodrigue at Hofstra University in New York provides an excellent depiction of a market cycle and the emotional rollercoaster that can leave some people with whiplash, wondering what just happened, in the graph below.

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A good steward does not pin his success to hope and randomness. Instead a good steward intentionally develops a process that is focused on how best to provide a positive outcome for the owner. As a steward of our client’s wealth, CWM has developed an investment process that is disciplined and intentional. We recognize that our decision making is vulnerable to headlines, gossip, opinions, perceptions, rumors and/or perceived expertise. As much as we may study the markets, there is even more that we do not know. It is the unknowns, the “Black Swan Events”, that are major disruptors to people’s lives. By systematically reducing portfolio risk, we align ourselves with our clients as they keep their eyes on their future plans, not on day-to-day headlines.

Currently our investment process indicates that we are in an overbought market, and we are in a greedy market. Our analysis tells us that that over the next two years, bonds may outperform stocks, so we are proceeding cautiously for the time being. For those familiar with our investment process, our current Performance Targeting System (PTS®) score is 1.66, meaning that we remain cautious in our equity exposure, and we are finding value in conservative positions.

Key market moves here in the United States continue to be based on the effects of the federal tax legislation in December, which caused a significant market rally in January. This market rally is causing concern of a fiscal stimulus at a market top and inflationary pressures. According to the Institute of International Finance the federal tax package could set off a global competition to reduce tax rates and reduce tax revenue in vulnerable countries.

On the positive side, corporate earnings continue to be positive, finally topping the highs that were seen in the first quarter of 2015. The chart below shows historical corporate earnings of the companies that make up the S&P 500 Index which are reported on a quarterly basis.

_{Source: Stockcharts.com}

As we see corporate earnings improve, we should see stock valuation metrics improve. Currently, the Shiller P/E Ratio remains at a staggering 33.06 as of February 16, levels that have only been seen during the dot-com market cycle.

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At the same time, the central banks of Europe, Japan, England and the United States have begun to implement their quantitative tightening programs to reduce their balance sheets. The global quantitative tightening by central banks could result in increasing interest rates as demand for government bonds goes down and supply increases. Bank of America Merrill Lynch projects that the Federal Reserve, Bank of England, European Central Bank and Bank of Japan will begin a decrease in their balance sheets beginning this year.

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The fear of inflation and global quantitative tightening programs are among the main reasons why we are seeing the interest rate on the U.S. 10-year Treasury break out of its 30-year pattern. The 10-year Treasury is considered by the investment world to be the standard for high quality government bonds, so many investment products, loan product, and market analysis are based on this key rate. For example, the traditional 30-year fixed mortgage rate is usually linked to the U.S. 10-year Treasury note. When we see a significant move in the 10-year Treasury rate, it often signals a move to the investment community as a whole.

_{Source: Yahoo Finance}

The IIF reports that global debt has hit an all-time high of $233 trillion in 2017. The chart below shows the record debt levels of corporations, governments and households.

_{Source: Institute of International Finance – Global Debt Monitor “Hidden vulnerabilities” (January, 4 2018)}

As interest rates begin to creep up, servicing these debts at higher interest rates may become difficult for those who are depending on low interest rates to survive. This could be seen as a headwind to potentially suppress future economic growth.

We continue to believe that the market has tremendous opportunities in the long run, and we are optimistic about the future. As stewards of our client’s savings, we believe our directive is to protect our client’s wealth and provide a portfolio investment process that adjusts for market risk. As such, in the short-term, we feel there is a higher probability of long-term success if we maintain our current conservative positioning.

Your future is too important to leave it up to the whims of Wall Street. If you are interested in discussing how you can proactively develop a plan for the future, we are always happy to schedule a time to talk.

Article by Marc Knauss, CFP®, former member of the CWM team

This article has been prepared and distributed for informational purposes only and is not a solicitation or an offer to buy any security or investment or to participate in any trading strategy. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a financial professional. Past performance is no guarantee of future results.