How Bad has it been for an Average Investor, so far?

Risk to investors can be defined in many ways.  A traditional measure of investment risk, standard deviation of returns, tells us what the historical variation of return has been around an average return. That is a good textbook measure but is a bit academic for real life investors.  Instead, most investors now like to look at “drawdown”, a measure that shows a percentage lost from recent highs, i.e., “peak-to-trough”.

The Great Recession emanating from the financial crisis in 2008 produced a well-documented drawdown of -55% in the S&P 500 hitting its low on March 9, 2009 retracting from its high on Oct. 9, 2007.  The duration of that drawdown lasted 1.4 years.

How does this drawdown compare, so far?

As far as duration goes, we have just started!  The recent S&P 500 high was on February 19 and the low was hit on February 28, so this drawdown period has lasted just 9 days – and we are currently off the lows!!  The drawdown percentage so far is -12.4%.

But, most investors have a diversified portfolio of stocks and bonds.  How have these portfolios done compared to an all-equity portfolio made up of just the S&P 500.

I like to look at a series of relative risk indices produced by S&P Dow Jones Indices.  They provide index values for global risk-based model portfolios ranging from Conservative (20% stock and 80% bonds) to Aggressive (100% stock) in 20% increments.  As you can see below, thanks to the impact of the rallying treasury and investment grade bond markets, as of now the drawdown percentages are modest compared to an all-stock portfolio.  A moderately conservative diversified portfolio is down only -3.3% from its recent high, a moderate portfolio is down -6.4%, but a moderately aggressive portfolio is down -9.2%.  

No one knows what the long term impacts of the coronavirus will be and how long this capital market turmoil will last.  Certainly, fear has gripped the market as demonstrated by the volatility and 1,000-point swings on the Dow and the tremendous flight to quality we have seen in the treasury bond market.  We continue to monitor the situation closely and continue to be hopeful for a relatively quick resolution as we have seen in other health crises. Actions by the Fed are helpful, but we look to prudent actions from local, state, and federal governments in the U.S. and around the globe to alleviate the situation.

What Now?

When I wrote my blog post titled The Quiet Rally on Feb. 21 about the historically strong bond market, I had no idea that the bond market would move so quickly to further strength.  As I said back then,

However, there are some strong fundamentals currently supporting a continuance of a low rate environment including the strong and rallying dollar, modest and stable U.S. growth with low inflation countered by tepid global growth, as well as external factors like the coronavirus.  Alternatively, there seems to be a less convincing case for rates to rise per an accelerating global economy and inflation that seems less likely in the near term.

Since then, the Fed came forward with a special rate cut of 0.50% to help head off negative economic effects emanating from the coronavirus.  The 10-year Treasury yield continues to plummet through today at a new all-time low of 0.93%.  Global equities are a rollercoaster with 1,000-point up and down days on the Dow becoming commonplace. 

So, what now?  If you had some fresh cash to invest, where would it go?  Is today the right time to enter the market? 

In a low rate environment, bonds are always held more for their negative correlation to risky equities than to generate total return.  Mathematically, current yield to maturity of a bond is a rough proxy for total return over the duration of the bond, so any allocation to 10-year Treasuries is only likely to return about 1% over the next 9-years!  Not a good way to grow a retirement portfolio!  Of course, there are other bond classes that offer higher yield and total return potential like investment grade corporates, U.S. high yield bonds, and emerging market bonds, but those investments involve taking some credit risk.

Income-generating equities like high dividend stocks and real estate investment trusts are currently yielding much more than bonds while providing some long-term upside total return potential, but are risky (as we know!!)  The FANG stocks were market leaders and certainly have a strong investment thesis, but as we have seen, are susceptible to drawdowns just like any stock.

Warren Buffet, renowned investor, is known to prefer buying when others are “fearful”, so perhaps this is the time to buy?  Maybe, except that Buffet’s Berkshire Hathaway is known to currently have their largest cash position in their history at $128 billion!

I refer back to my recent post Invest All-at-Once, or Over Time? where I advocate a methodical dollar-cost averaging approach into an appropriate risk-based globally-diversified multi-asset investment strategy to help smooth out these bouts of market turbulence.  This is despite the research that shows “on average”, investing all-at-once produces higher long term returns.

Panic-Stricken

When I wrote my Special blog post, Rally, Disrupted, on Monday describing the market events emanating from the coronavirus outbreak, no one had any idea that the market psychology would balloon into a full-grown panic.  The idea of “sell first, ask questions later” took hold.

Punctuating this thought, the World Health Organization Director-General Adhanom Ghebreyesus was quoted in the media today saying “Global markets should calm down and try to see the reality.  We need to continue to be rational”.  Also saying, “Based on the facts on the ground, containment is possible, but the window of opportunity for containment is narrowing.  So, we need to prepare side-by-side for a pandemic”.

Of course, no one knows how this situation will play out.  Containment consistent with the SARS and other outbreaks would bring things back to normalcy relatively quickly; whereas, unknown dire consequences are being priced into the markets.

U.S. equity markets sold off from all-time highs only a week ago being down -12% from that high and down -8% for the month of February.   Other markets followed suit, as well, with emerging markets down -8% and international developed equities down -7%.  Offsetting these losses in the capital markets were core bonds and investment grade corporate bonds both up about 2% that acted as a flight to quality.  Moderate risk balanced portfolios of stocks and bonds were down about 5% during the month of February.

Outlooks from investment thought leaders gives some perspective to the situation and only a few are recommending selling.  Jeremy Siegel, noted investor and academic from University of Pennsylvania, was on CNBC a few times during the week and continued to feel that though we are suffering short-term losses, a long-term investor will be rewarded by sitting tight.  Arguably, if you are not a long term investor you should not have an undiversified position in risky equities in any event.  Also, most of the tactical managers that I follow (i.e., the managers who have models to get in and out of the markets) were still “risk on” through Friday night.  That includes Beaumont Capital and Julex (my previous firm that I co-founded). 

So, it is really two questions: when (if?) to get out and when to get back in.

For a long term investor, I currently believe staying the course is a prudent approach.  I think there is a strong risk of getting the sell (and buyback) decision wrong.  This would be the classic “whipsaw” effect where you sell and buy at exactly the worst times as the trends move against you.  I have kept all client positions intact thus far.  I expect if we start seeing some demonstrated fundamental (and technical) economic and capital market statistics pointing to a further large market drawdown (such as diminished industrial PMI, depressed earnings, pronounced negative price momentum, etc.) that could develop into something akin to the Great Recession, I will take everyone to a less risky profile.  The environment is not there yet.

Lastly, in order to avoid having misinformation cause you undue stress, the most reliable source for information right now is from the Centers for Disease Control and prevention (CDC) that can be accessed at https://www.cdc.gov/coronavirus/2019-nCoV/index.html. I will be following this developing story very closely and will post frequently as appropriate.

Rally, Disrupted

My recent blog post on Feb 21 titled “The Quiet Rally” highlighted how bonds had continued to improve on strong returns garnered in 2019.  I made the point that “market timers” might view the bond market as near a top, but that there were many factors, including “external” factors, that could continue to support a low rate environment.  Then, Monday Feb. 24 happened!

The Dow was down -3.56% (-1,033 points), the S&P 500 was down -3.35% (-111 points) and the NASDAQ was down -3.71% (-355 points).  Meanwhile, the flight to quality supported bonds with the 10-year Treasury bond price being bid up to force yields lower by 10 basis points for a yield of 1.37% and broad aggregate core bonds (SCHZ) rallied with a daily total return of +0.31%.  All of this was due to news on the coronavirus turning worse over the weekend with reports of new cases in Italy and South Korea.

The human tolls are high with over 77,000 infections and 2,529 deaths through today; mostly centered in China.  But, rapidly expanding infections around the globe seem to be developing quickly such as reports of infections in northern Italy.

The economic and financial impacts have not gotten a hold yet, but most forecasts are starting to portend the potential for a large realized impact.  Most of the potential problems are centered on industries dependent on supply chains from China, but other industries like tourism and airlines are also subject to problems due to potential quarantines and travel restrictions.

Certainly, there is a good level of uncertainty as to how the coronavirus problem will play out.  It appears that the coronavirus is more contagious and more prone to incubation periods than other flu epidemics.  Its impact on the economic and financial situation is not a complete unknown, but any attempts to gauge an expected outcome is prone to be wrong with a large margin of error.  So, as one market observer said, “sell first, ask questions later!”

What needs to happen for there to be a “sell” trigger?  I would look for a prolonged disruption in earnings and earnings growth to portend a deep sell off.  Also, we would need to see any disruption to be material.  Stock values are dependent on earnings; and forecast earnings are one thing; realized disruption in earnings is another.  Also, we will be watching closely for other factors and unknown “black swans” that could disrupt the markets.

Invest All at Once, or Over Time?

If you got a lump sum of money all at once, what would you do?  Would you invest the money immediately, or invest it slowly over time?  This decision point comes up all the time, especially in the case of large employment bonuses, cash inheritances, or any other “liquidity event”.

A common rule of thumb encourages a methodical “dollar-cost averaging” approach over some time horizon, like 3 or 6 months, where parts of the cash is invested to a target strategy.  The idea, of course, is to avoid “market timing” and investing the entire balance at an inopportune time; for example, at a market top before a selloff.  Dollar-cost averaging keeps the uninvested balance in cash, so the net result is an overall “less risky” profile compared to being fully invested.

There are some exceptions to this rule of thumb.  For example, if the investor has a long time horizon and has a high risk tolerance there is no reason to be overly cautious getting invested to a target investment strategy.  Also, if the new cash is a relatively small component of the investor’s total portfolio and not expected to impact the risk prolife, there is no reason to move slowly.

For every rule of thumb, however, there is a contrary view.  Morningstar recently published an article titled, “The Dollar-Cost Averaging Myth” (Morningstar Magazine, 2020 Q1), where they attempt to debunk this approach.  Through statistical simulations, they showed that dollar-cost averaging actually was a form of market-timing and, depending upon the scenario path, would produce less return and be more risky compared to a lump sum approach.  Over a series of 10-month investment scenarios, the authors showed that dollar-cost averaging outperformed lump-sum investing only 27.8% of the time.

This is a logical conclusion since the market usually goes up and we would expect the “less risky” dollar-cost averaging approach to underperform “on average.”  Importantly, however, the authors did not address a drawdown event that could wipe out 10%, 20% or 50% of a portfolio if the lump sum is timed incorrectly; something most investors are very concerned about!

So, best to be mindful of your risk tolerance and ensure that your investment approach is consistent with it to help ensure you will achieve your investment goals.

The Quiet Rally

Stock market news gets reported every day on the mainstream media and usually gets a headline when new all-time highs or big losses occur.  Bonds, on the other hand, rarely get a headline.  The current environment, however, has prompted some notice! 

Just when you thought the bond market couldn’t get any stronger, bonds are quietly hitting new all-time highs.  As reported in a Bloomberg article last night (https://www.bloomberg.com/news/articles/2020-02-20/vanishing-spreads-are-ringing-alarm-bells-in-risky-debt-markets), many types of bonds including U.S. investment grade and high yield debt continue to trend higher with strong bond returns.  As reported in the article, U.S. investment grade corporate bond yields set a new all-time low of 2.56% with 10-year treasury yields bottoming at 1.49% overnight.

Some of the most popular bond ETFs are putting up strong year-to-date returns.  The iShares Investment Grade Corporate Bond ETF (LQD) is up 3.02% and the Schwab U.S. Aggregate Bond ETF (SCHZ) is up 2.21% so far in 2020.  This is against a backdrop of strong, yet volatile, equity returns where the S&P 500 (IVV) is up 4.72% YTD.

The strong bond market so far in 2020 follows a surprisingly strong bond market in 2019 where U.S. investment grade bonds (LQD) were up an astounding 17.4% and the broader core bond category (SCHZ) was up 8.6%.

Though behavioral biases may lead many investors to shy away from investing at the perceived “top” in this market, a long-term strategic investor should not make market calls.  However, there are some strong fundamentals currently supporting a continuance of a low rate environment including the strong and rallying dollar, modest and stable U.S. growth with low inflation countered by tepid global growth, as well as external factors like the coronavirus.  Alternatively, there seems to be a less convincing case for rates to rise per an accelerating global economy and inflation that seems less likely in the near term.

Long-term strategic portfolios that are broadly diversified to include a broad mix of stocks and bonds of different types and managed to the appropriate risk target to achieve goals will be rewarded over time. 

Investments 101: Why REITs?

Real estate has historically been a great investment for long term price appreciation, income generation, and inflation protection; but, it is risky!  For investors who want liquid exposure to this asset class, the capital markets provide the real estate investment trust (REIT) legal structure.  When you buy a REIT you are buying into the REIT organization’s management skill to manage the properties successfully to generate price and income return.

The major real estate sectors include industrial, office, retail and residential, but there are other minor sectors like resorts, health care, self storage, and timber.  For example, if you want to have investment exposure to large shopping malls in the U.S., you could buy shares of the giant retail REIT, Simon Property Group (SPG), that owns and manages over 200 retail malls and properties.  Or, if you preferred cell phone towers, you could buy shares of American Tower Corp. (AMT).  And the list goes on, including almost any other type of real estate you can think of!

However, as we all know, real estate goes through boom and bust cycles and is a risky asset class.  Moreover, just like with regular stocks, buying an individual REIT exposes the investor to “idiosyncratic” risk, i.e., a risk unique to that specific investment that can not be diversified away.  Because of this, it is much preferable to own real estate through a portfolio of REITs.  There are a few very large low-cost passively managed exchange-trade funds (ETFs) that provide good diversified exposure to the REIT sector.

REIT offerings from Vanguard, Schwab, and iShares round out the top few passively managed REIT ETFs.  As seen from chart below, their performance over the past five years has lagged the S&P 500, while having more risk!  REITs still have a place in a balanced portfolio due to its low correlation (about 0.5) to the S&P 500 and its historically relatively high income generation (as shown from their higher SEC yield compared to SPY).

A key component driving returns are the underlying sector exposure of each of the ETFs.  As can be seen below, VNQ and IYR tend to underweight the Residential sector compared to SCHH, thus impacting the return profile.  There is no reason, however, to believe that one weighting approach is better than the other over a full business cycle.

As always, our philosophy is to have a well-diversified global multi-asset class exposure that includes the real estate asset class through the liquid low-cost passively managed ETF structure.  We expect to be rewarded over a long term time horizon.

Lucky Than Smart

Occasionally, it works out that you are more lucky than smart.  That is the way I feel about an A-class mutual fund I bought for my 4-year old son as a custodial account way back in 1989!  This was before exchange-traded funds (ETFs) and the proliferation of passive strategies.  I knew I was getting a better deal than otherwise since my employer allowed me to buy it without a sales charge, but I had no foresight that the fund would continue to perform as well as it did… right through today!

We still hold the fund, MFS Growth Fund (MFEGX), in my son’s name.  It is hard to calculate the exact total return over the past 30.5 years, but according to Yahoo Finance Adj. Close Prices from the earliest date available (January 3, 1993), its cumulative total return is 999.83% ( +129.01/11.73) that compares very favorably to an S&P 500 index fund (VFINX) of 1,172.04% (+309.87/24.36)!

Over the past 10 and 15 years, however, its return has been more extraordinary against the S&P 500 and even against its growth benchmark, the Russell 1000 Growth Index.  From the table below per Morningstar data, you can see the extraordinary 11.98% annual return and its +1.40% per year advantage compared to its growth proxy (IVW) over the past 15 years!

For an impressive MFEGX visual story (the blue line on top), just take a look at the chart below from Morningstar; $10,000 invested 15 years ago would have grown to over $54,000 today compared to only $28,000 for SPY or $36,000 for IVW.

The message here is two-fold.  First, congratulations to me for picking a winner over 30 years ago and seeing it continue to be one of the top growth funds in the mutual fund industry over the recent 15 years.  Secondly, and more troubling, is the fact that it was more luck than skill because I bought it 30 years ago in an environment of active management and high fees and history shows that this combination more often than not leads to underperformance (check SPIVA reports at https://us.spindices.com/spiva/#/ for pertinent analysis of this point)!

At that time I most likely would have bought a laggard and would be bemoaning the situation today.  Instead, I am quite happy that I ended up on the positive side of the ledger with the odds stacked against me.  Given what we know now, best to play with the odds stacked in your favor by focusing on low fee and passive strategies with minimal carefully selected exposure to high fees and active management.

Random is as Random Does

Capital market returns are often viewed as random.  The classic book by Burton Malkiel, Random Walk Down Wall Street, originally published back in 1973 with multiple updated editions, covers this in a readable format.  How can we observe this graphically?

Callan Associates is a well know consulting firm that publishes their annual “periodic table” of asset class returns.  The table arrays different asset class returns over different time horizons against each other.  In this way, you can graphically observe the rotation of returns compared across asset classes.

In the following exhibit I have plotted the monthly returns for 20 different asset classes (represented by their appropriate ETF) that cover a broad spectrum of the capital markets.  Each monthly return is sorted by highest to lowest monthly return.  I highlighted with arrows how the S&P 500 (light blue) and Small Cap Equity (bit darker light blue) rotated during 2019 through January 2020.

As you can see, both the S&P 500 and Small Cap Equity moved up and down the chart.  As expected, the Small Cap Equity showed more movement and, thus, more volatility (risk) than the S&P 500. 

I added Apple stock (AAPL, dark gold) for comparison.  As you can see, Apple stock mostly occupied the top three rows for the past thirteen months!  This does not mean it does not have risk; it is just that the time horizon is too short.  Likewise, Tech (dark red) occupied the top three rows over this time horizon (probably because Apple is a large component of that ETF).  The same logic can be traced for the other color-coded asset classes like REITs, investment grade bonds, and emerging market equity.

Can anyone predict how these asset classes will transition month-to-month?  NO!  Best to be well-diversified across all the major asset classes to capture the returns when they emerge over time.

January Smorgasbord

Between the U.S. attack in Iran, the escalation of the Coronavirus, the lead up to the Brexit effective date, and the impeachment hearings, January was certainly chock full of potentially market moving events.  None of those events, however, stopped the S&P 500 from hitting new record highs in the middle of the month.  Unfortunately, the end of the month (especially the LAST DAY!) showed a retraction to erase all the gains of 2020! 

The positive factors of good economic growth, good corporate earnings and “easy” fed policy led capital market results before the markets eventually ceded to the culmination of all those foreboding events.  The risk of “uncertainty” is a strong behavioral bias that leads markets in the face of an otherwise positive fundamental situation.  Certainly, any one of those events could lead to a deteriorated market condition; put them together and you have a good recipe for “uncertainty soup!”

For every weak idiosyncratic stock story (e.g., ExxonMobil, Chevron, 3M, and Boeing), there seemed to be an equal and offsetting positive story (e.g., Amazon, Alphabet, Apple, IBM, and Tesla(!).

Likewise, there was a broad dispersion of broad asset class winners and losers during January.  The S&P 500 (IVV) ended January 2020 exactly unchanged, whereas utilities (XLU) and technology (XLK) held their returns being up 6.7% and 4.0%, respectively.  Factor positions such as momentum (MTUM) and low volatility (USMV), similarly, regained market leadership with respective returns of 3.7% and 2.4%.  High dividend stocks struggled to keep up with mostly neutral returns, whereas the most aggressive sectors of the global economy such as emerging markets (dealing with the China Coronavirus issue as “ground zero”) were down the most at -6%.

In the global capital markets that turned to “risk-off” at the end of January, fixed income assets regained favor with core bonds (SCHZ) being up 2%.  Investment grade corporate bonds (LQD) did better by recapturing their “rally hat” during January with returns of 2.5%.

During times of heightened market uncertainty, when there appears to be the creation of a market “inflection” point, there is often pressure to make a market call and go to “risk-off.”  It is my view that it is way too early for that view; but certainly anything can happen.  Alternatively, this is an excellent time to affirm your risk profile and be assured that you are exactly where you should be to achieve your goals. 

MAGA? 4 Trillion-dollar Companies!

I follow about 400 investment thought-leaders on Twitter.  One of them, Charlie Billelo from Compound Advisers, made an interesting observation today.  Namely, with the great price rally in Amazon (AMZN) today, there are now 4 stocks with a trillion-dollar market capitalization (share price times shares outstanding) and the tickers all spell out MAGA (Microsoft, Amazon, Alphabet (GOOGL), and Apple)!

I have commented before on this idiosyncrasy of a cap-weighted index (such as the S&P 500).  From my blog post back in October 2019, I noted that the top 10 stocks in the S&P 500 made up 22.1% of the index; today that percentage has grown to 23.6%.  It almost goes without saying that exposure in the S&P 500 is less diversified than otherwise; especially since there is a strong growth style and tech/communication sector bias – and even stronger tech bias if you include Amazon in that category!

As I said in October, and it is worth repeating today,  “Though it is nice to capture the “upside” of the large overweight to “growth” stocks, it will not be so nice to experience the downside risk that is sure to follow it someday; growth stocks tend to exhibit more volatility of return than the S&P 500.  Best to stay broadly diversified across all market sizes and characteristics to capture the inflection points when they occur.”

What Does AI Think of this Market?

As most readers of this blog know, I am a fan of some aspects of an artificial intelligence (AI) methodology to insulate portfolio management from behavioral biases.  One of my favorite vehicles for this is the AI Powered Equity ETF (AIEQ).  What are the portfolio holdings today and what can we learn from them?

I downloaded all the holdings from last night and see some interesting positions.  Some top holding names, like Alphabet (GOOGL), Amazon (AMZN) and Costco (COST), are expected, but others, like Estee Lauder (EL), are less expected.  Looking at all the other larger positions in AIEQ reminds me of the “Peter Lynch” investment approach of buying names that “you know and use everyday.”  The AIEQ list goes on to include Facebook, Mastercard, United Health, and Johnson & Johnson; certainly, household names!

From a top-down perspective, I was curious what investment factors are driving security selection? I used PortfolioVisualizer.com to calculate investment factor exposures in the current AIEQ portfolio.  For the four major factors being Size, Value, Momentum, and Quality, I was surprised to see only a small 0.32 bias favoring the small cap Size factor and almost no bias to Momentum, Value or Quality.  All of this while the AIEQ ETF produced a YTD total return of 4.43% beating the S&P 500 of 3.15%.  

The AIEQ investment approach is carefully guarded, but from these statistics it appears that factor analysis is not part of the formula.  From the AIEQ web site, the AI model is targeted to combine fundamental and technical methods to produce a better probability of capital appreciation at similar levels of risk of broad stock indices.

What's in a Name?

Identifying a client’s risk profile is the most important factor to consider before implementing an investment plan.  Items like client age, wealth, cash flow needs, etc. all come together to lead to a single answer to the amount of risk a client can tolerate.  But, what does it mean when it is determined that their risk profile is “moderate”?

Most of the answer settles on the asset allocation split between equities, fixed income and cash.  As we all know, equities are generally more risky than bonds and cash.  But, not all equities and bonds have the same amount of risk so we need to look further into the underlying characteristics.

For example, modeled historical measures of standard deviation of return (i.e., statistical measure of variability around the average return) and “drawdown” (i.e., peak to trough return volatility) are useful to help categorize the risk profile of a portfolio.

Being able to measure the underlying risk of a strategy is critical because simply saying “moderate” does not get you to a universally-accepted approach.  For example, I am aware of three funds that have the word “moderate” in their name but have very different approaches and risk profile.  Per the table below, you can see that large variation in return and risk.  So, though MAMAX has top returns, it also has top standard deviation of return and drawdown!  Interestingly, AOM with the lowest return has the highest amount of return per unit of risk (1.54).

So, best that any investment strategy includes a recognition of the underlying metrics supporting the risk profile and not just settle on a name!

Factors Matter!

The smart guys at Newfound Research highlighted a few key points from the 2019 market performance in their annual review.  A key one for me was the significant lag in “factor” performance, i.e., the academically-supported expected performance premium to be garnered from key underlying traits of stocks.  The major “factors” that underperformed were stocks with a high trait of value, size, momentum, and low volatility; only the quality factor was close to break-even versus the S&P 500.

They go on to say that periods like this are not a huge negative outlier.  But, what is huge is the fact that all of them underperformed at the same time during the same time horizon!

So, what is the lesson here?  My investment philosophy is grounded in a globally-diversified, multi-asset long term strategic approach to capture market returns and manage risk.  Exposures to the well-documented “factor” space is part of that viewpoint.  It is unrealistic to expect each and every asset allocation choice to outperform each and every period.  In fact, due to normal market volatility and a rotation of returns, I would not be surprised to see factors outperform core holdings in the future; we shall see!

Where's the Beef (data)?

From someone who grew up in the dark ages of IBM PC’s, floppy disks, and 28k modems for online access, we have certainly come a long way; especially as it relates to access to financial data.

I recently chatted with a colleague and we discussed sources of market information.  Bloomberg, of course, is the info giant for financial information; a one-stop online shop for almost everything financial with great analytics, but at a steep price!  However, they don’t have a monopoly on data and analytics and a lot of what they offer can be gotten for free on respected sites.  Following are a few of our favorite sources of data and analytics.

For raw data, Yahoo finance is a good first place to check.  One of my favorite features to help calculate total returns for stocks, mutual funds, or ETFS is the “Historical Data, Adj Close” data.  This data adjusts the price of the security for dividends paid so that a pure “total return” calculation can be done; very useful to track performance between two dates that aren’t on an even month- or quarter-end.  Simply divide the ending value by the beginning value to get a total return including price and income return.

The “Chart” feature on Yahoo Finance is also very robust.  It allows price charting for custom date ranges with comparison to additional securities.

For pure raw data with a focus on economics, you can not beat the FRED site sponsored by the Federal Reserve Bank of St. Louis.  They have populated all the official data for all the economic statistics you could ever need into a handy online interface.  Data series like official historical inflation, GDP, and industrial production, as well as financial data like credit spreads, yield rates, and S&P 500 are all there and easily accessible.  In fact, it includes access to over 500,000 financial and economic data series (who knew there were that many!!)

I have a few other favorite sites that focus on analytics I will post next week.

Q4 Caps Super 2019

The markets love a dovish Fed and that is what it got in 2019.  Going into 2019, there was a prospect of higher rates that was quickly squashed by a data-dependent Fed that cited potential economic weaknesses here and abroad.  The Fed reversed course and pointed to lower rates.  Easing of global trade concerns helped, too!  The S&P 500 responded accordingly with a stellar 2019 total return of 31.49% (including dividends), the strongest annual performance since 2013.  Q4 showed a continuation of the trends set up earlier in the year with equities extending their gains and bonds showing some weakness due to yield curve steepening.

The equity rally was broadly based with some relative winners and laggards.  During Q4, large- and small-cap equities represented by the S&P 500 (IVV) and the DJ U.S. Small Cap Total Market Index (SCHA) were strong performers with both being up about 9%, while mid-cap (SCHM) lagged at 7%.  Factor plays, that are expected to outperform over a full market cycle, also lagged in Q4 with momentum (MTUM) and low vol (USMV) producing returns of 5.72% and 2.95%.   Real estate investment trusts (SCHH) gave back some of its big gains earned earlier in the year with Q4 returns of -1.95%.  Finally, of all the major broad asset classes, emerging market equities (IEMG) led all markets in Q4 with a 12.18% return.

Fixed income markets were less bullish in Q4 due to the yield curve steepening prompted by Fed easing and the market taking long rates higher.  Core bonds (SCHZ) were mostly flat with a Q4 return of 0.10%.  Bonds with some credit spread were the winners in Q4 with emerging market bonds (EMB) and high yield bonds (HYG) leading the pack with returns of 2.56% and 2.48%.  Likewise, short bank loans (BKLN) with some credit spread improved with a 2.20% return.

So, will this trend continue?  Most of the indicators I follow point to a bullish “risk-on” sentiment for the near term.  But, as I reported in my Dec. 1 blog post, “My Favorite Chart”:

Fans of “reversion to the mean” will be anxiously awaiting the S&P 500 retraction whereas “momentum” players are looking for more gains.  We shall see; best to stay well-diversified in a portfolio managed to your appropriate risk-profile.

20/20 Foresight?

Former Fed Chairman Alan Greenspan was quite opinionated on our ability to forecast capital markets.  He is known to state that we aren’t very good at forecasting, but we have no choice but to forecast since every position we take implies a forecast.  He even goes so far as to say that a forecast, by virtue of its presence, changes the environment such that it creates an arbitrage situation impacting the forecast.

The previous thoughts notwithstanding, this is the time of year when all the investment thought leaders put out their forecasts for the coming year.  It is always interesting to see what themes emerge and to parse out the nuggets that stand out.  I am always fascinated about how wrong these forecasts can be, however.  For example, the Wall Street Journal last year famously showed a survey of economists where EACH AND EVERY ONE “wrongly” predicted higher rates in 2019 (see my previous blog post here: https://www.dattilioash.com/our-blog/2019/6/13/interest-rate-forecast-foible).

This year, Wells Fargo Investment Institute came out with their fairly modest view for 2020.  Following is a table of the big highlights:

You can read the full report yourself here, if interested: https://d2fa1rtq5g6o80.cloudfront.net/wp-content/uploads/2019/11/6600703_WIM-CM_Q3_WFII-2020-Outlook-Report-Paper_A1_F1_a11y_reduced.pdf. 

It is good reading and tells a good story, but will 2020 play out as forecast and produce good capital market returns?  As I have re-counted before, “Beats Me!”  But, I will be watching closely!

A No-Tax Situation

Most investors are aware of tax loss selling, i.e., sheltering income by selling securities at a loss to reduce taxable income in a calendar year. However, there is another situation where selling securities at a “gain” is equally advantageous. For investors filing as an individual with taxable income under $39,375 (or other income limits for different filing categories), the federal tax rate on long term capital gains is 0%!

Selling securities at a gain in a taxable account with no tax liability is very attractive economically. Granted, you need to have low taxable income to qualify, but there are many reasons why a person could be in this situation. For example, you could be a young person with some savings in a taxable account just starting a career with an entry-level pay scale with more earning potential in the future. Or, you could be a retired worker with lots of savings in a taxable account, but not much income in any given year (for example, before you elect to begin social security payments).

Regardless of your specific situation, it is always beneficial to consider this feature of the federal tax code to see if it saves you taxes. The net result of this activity is to increase your cost basis for tax purposes. For example, let’s assume you have a position in an S&P index fund with a $10,000 unrealized gain. Selling that position and reinvesting into another similar-type investment increases your tax cost basis, thus completely eliminating your embedded tax liability that could be a factor in future tax years; perhaps when you have taxable income over the limit and would be liable for a tax payment.

There are a few other things to consider, of course. For example, there may still be a state or local tax liability that needs to be paid. Or, if the investor is claimed as a dependent there could be a kiddie tax consideration. It is best to consult with a tax adviser who can give a complete analysis and recommendation in support of this tax management strategy.

Nice November

Like October, November offered plenty of geopolitical intrigue with ongoing dialogue on China trade, impeachment inquiries, and comforting Fed-speak, but the combination of all these countervailing forces prompted strong equity markets.  The S&P 500 kept up its torrid pace setting new all-time highs, while other equities tried to keep up.  In the fixed income space, core bonds were mostly flat, while bonds with some credit risk posted modest positive returns.

The S&P 500, with its huge weighting of 22% to just 10 stocks, returned +3.64% for the month.  Other core equity plays like small cap (SCHA) and mid cap (SCHM) also performed well with returns of 3.92% and 3.88%, respectively.  Action in the “factor” space of momentum and low vol spent another month with modest lagging returns of 3.29% and 1.39%, respectively.  An “AI-managed” ETF (AIEQ) insulated from behavioral biases, pulled out another winning month with a 4.96% return for the month and YTD S&P 500-beating returns of 28.46% (versus 27.52% for the S&P).  High div plays mostly lagged a bit, but rising dividend yields portend higher returns in the future if market rates stay low or go lower; same goes for REITs.

The bond market, taking a breather from its scorching pace through September, stayed calm with some pockets of positive return.  Core bonds (SCHZ) were mildly negative with a -0.09% returns while bonds with credit risk like investment grade corporates (LQD), high yield (HYG), and bank loans (BKLN) gave positive returns of 0.47%, 0.57% and 0.61% respectively.   

Tactical players in the asset allocation space struggled during the month.  The Morningstar Tactical Allocation Category produced an average return of 1.41% for the month, while one notable asset allocator, the Cambria Global Momentum ETF (GMOM) earned negative returns for the month of -0.46%.  Just another indication of how “smart” money can be wrong!

One month is never enough time to gauge the effectiveness of a long-term strategic investment strategy.  These monthly checkpoints let us gauge the individual winners and losers.  We don’t expect each investment to outperform each and every month; but, instead are looking for a positive gap for the whole portfolio of investments over a full market cycle.

My Favorite Chart

This chart is one of my favorites.  It maps the performance of the S&P 500 (SPY) versus the Aggregate Bond Index (AGG) and other risk-managed portfolios from Conservative to Aggressive (Dow Jones Portfolio Indices).

I updated the chart though October 2019 to reflect the extraordinary market recovery from the depths of Q4 2018.  I like this chart for mostly one reason; it shows the dramatic trade-off between risk and return.

The solid black line shows the path of the S&P 500 (SPY); very choppy and subject to big drawdowns and big recoveries.  The Aggregate Bond Index (AGG) is the mostly flat green line.  Each of the risk-managed portfolios of global stocks and bonds occupy the space between those boundaries; ordered appropriately with the most risk outpacing the lessor risk.

It is interesting to note that the Aggregate Bond Index actually outperformed the S&P 500 from 2008 through 2013; and then fell woefully behind since then.  The S&P 500 since 2013 has been on a tear widening its outperformance to the risk-managed portfolios with each subsequent month.

Fans of “reversion to the mean” will be anxiously awaiting the S&P 500 retraction whereas “momentum” players are looking for more gains.  We shall see; best to stay well-diversified in a portfolio managed to your appropriate risk-profile.