In our 2018: The Year Ahead, we expressed our concerns with volatility returning to the markets. As the S&P 500 fell 10.2% from its recent high, spooked investors played into the media frenzy, once again proving investors are irrational. This recent wakeup call was long-overdue: 9 years into a bull market, investors tend become over-confident and start to believe a self-directed strategy can beat the market, or at the very least out-perform their financial advisor. This month’s issue of The Samra Report provides insight on: what happened in February, recommendations for 2018, and what to expect for the remainder of the year. February showed more turbulence in the markets, than we have seen in sometime. However, investors should be made aware market corrections “of 5% have occurred three times per year on average since 1930, 10% corrections have occurred once per year on average, with a 15% pullback every two years”. Novice investors may have found the recent pullback to be alarming, however, the S&P 500 went over 400 trading days without a 5% pullback. Somewhat of an anomaly. Investors should understand corrections in the market are normal, whereas year-after-year gains are not.
What should have been a seamless transition, a handing over of the reins from Chair Janet Yellen to Jerome Powell. Janet Yellen broke from tradition: as expected the Fed left rates unchanged, however, a single statement about inflation started a domino effect, rocking global markets. On a fundamental level (in economics), the Feds has at its disposal the ability to prevent inflation by raising key interest rates. An increase in interest rates however, leads to a drop in the value of bonds, most recently causing a sell-off that rippled into the equity markets. At Samra Wealth Management, we believe Yellen’s statement was premature, given data the Fed Chair had available, and the assumptions made. January’s employment report showed the first signs of wage growth, something that has been absent in past employment data. The fact the Fed has placed an emphasis on employment numbers, without taking a deeper look at wage growth, and the prime-age labor force participation rate, shows a flaw in the Feds speculated plans to increase rates 4 times in 2018. A deeper dive into the data shows: the 3-month moving average of median wage growth and the percentage of Americans between the ages of 25 to 55 who are in the job market, have not recovered to where they were prior to the financial crisis. Given that millennials have a very different career game plan, and the fact: more corporations are diverting capital towards technology over human-capital, shows how out-of-touch the Fed is.
Some may speculate, this action by the former Fed Chair was an attempt to “stick-it” to President Trump, given the success of his presidency seems to be correlated to the financial markets. It is our belief, the President will have the last laugh, and although Chairman Jerome Powell has hinted at 4 rate hikes during 2018, we would not be surprised to see the Fed fall short.
The recent spike in volatility may have many investors questioning their portfolios with regards to safety. As we have mentioned in previous issues of The Samra Report, it is our belief Alternative Investments have a place in each of our clients’ portfolios, as we place an emphasis on modern portfolio theory. Investors should be cautious, specifically those with a flawed understanding of Modern Portfolio Theory. As it is not just the inclusion of Alternative Assets, however, as Harry Markowitz’s stated, “the idea that risk and reward is not only a function of a portfolio's individual holdings, but also how those holdings behave with respect to one another”. At Samra Wealth Management, we are redefining what it means to be a conservative investor. Recommending against US Government bonds, and strongly recommending against the use of annuities until the end of 2018. Questions conservative investors should be asking themselves:
- Why invest in US Fixed-Income (bonds), during what we believe to be a rising interest rate environment? (Supported by 3 Fed Rate hikes in 2017, and Fed Chair Jerome Powell’s hints towards 4 hikes in 2018. Increases in interest rates lead to a devaluation of a fixed income portfolio.)
- Although annuities offer fixed rate, or a margin of safety. Why lock into an annuity product, when we have strong reasons to believe interest rate hikes during 2018 will cause these same annuity products to offer higher returns at year-end?
- Has your financial advisor provided you with a “shock analysis”, an analysis showing the interest-rate risk of your portfolio? Essentially, quantifying for the investor how an increase in interest rates would negatively impact the value of a fixed-income portfolio.
- What alternative investments do you have as part of your portfolio, and how do they mitigate downside exposure?
We believe the volatility will continue throughout 2018, as algorithms and high-speed trading has caused a new-norm. A norm where 100-point incremental moves in the Dow Jones Industrial Average barely fall outside of 2-standard deviations of the mean. This volatility will likely prompt a scenario where investors allocate larger portions of their portfolios towards blue chip equities, specifically those with a historical record of paying dividends, as well as those companies likely to benefit the most from repatriation. The Federal Reserve Bank of New York uses as its recession indicator, the gap between the three-month treasury bills and the 10-year note: a current reading of 4.2%, far below the 20% threshold that is usually crossed before the S&P 500 reaches a peak. Investors should remain cautious about geopolitical risks, both foreign and domestic. We continue to monitor: rising tensions between the Kremlin and Washington, the escalated North Korean crisis, further troubles in the Middle East and the “Mueller Risk Index” (which began tracking March 2, 2018). Investors able to stomach the rollercoaster ride in 2018, are likely to be rewarded.
All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. The information and material contained herein is of a general nature and is intended for educational purposes only. This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor.
Stock Index prices are listed as of the close of business February 28, 2018, and do not take into consideration any reinvested dividends.
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