What's Going on in the Markets February 5, 2018

It's been a long time, more than a year, since I've posted an article about what's going on in the markets. Market volatility, until last week, has been mostly subdued. For what seems like years now, markets seemed immune from any meaningful drop. But this still young month of February has seen volatility return with a vengeance.

This means that the U.S. stock market will finally get something that happens, on average, about once a year: a 10+% percent drop—the definition of a market correction.  The last time this happened, known as a bear market, was a whopper: the Great Recession drop that caused U.S. stocks to drop more than 50%--so most people today probably think that corrections are catastrophic.  They aren’t.  More typically, they last anywhere from 20 trading days (the 1997 correction, down 10.8%) to 104 days (the 2002-2003 correction, down 14.7%).  Corrections are unnerving, but they’re a healthy part of the economy and the markets—for a couple of reasons.

Reason #1: Because corrections happen so frequently, and are so unnerving to the average investor, they “force” the stock market to be more generous than alternative investments.  People buy stocks at corporate earnings multiples which are designed to generate average future returns considerably higher than, say, cash or municipal bonds—and investors require that “risk premium” (which is what economists call it) to get on that ride.  If you’re going to take on more risk, you should expect at least the opportunity to get considerably more reward.

Reason #2: The stock market roller coaster is too unsettling for some investors, who sell when they experience a market lurch.  This gives long-term investors a valuable—and frequent—opportunity to buy stocks "on sale."  That, in turn, lowers the average cost of the stocks in your portfolio, which can be a boost to your long-term returns.

The current market downturn relates directly to the first reason, where you can see that bonds and stocks are always competing with each other.  Monday’s 4.1% decline in the S&P 500 coincided with an equally-remarkable rise in the yields on U.S. Treasury bonds last Friday.  Treasuries with a 10-year maturity are now providing yields of 2.85%--hardly generous, but well above the record lows that investors were getting just 18 months ago.  People who believe that they can get a decent, relatively risk-free return from bond investments are tempted to abandon the bumpy ride provided by stocks for a smoother course that involves clipping coupons.  Bond rates go up and the very delicate supply/demand balance shifts, at least temporarily, in their direction, and you have the recipe for a stock market correction.

This provides us all with the opportunity to do an interesting exercise.  It’s possible that the markets will drop further—perhaps even, as we saw during the Great Recession, much further.  Or, as is more often the case, they may rebound after giving us a correction that stops short of the technical definition of a bear market, which is a 20% downturn.  The rebound could happen as early as tomorrow, or some weeks or months from now as the correction plays out.

Most bear markets coincide with the onset or expectation of a recession. Some even debate whether a recession causes the bear market or vice versa. The good news is that all indications are such that a recession is not on the horizon. Jobs, housing and many other manufacturing and services data are quite strong, retail sales are healthy, and most importantly, consumer confidence are near all-time highs. While this could all change, it would take at least 9-12 month for conditions to deteriorate enough and make the probabilities of a recession more likely than not. That's why I believe that a bear market is not imminent.

A correction or even a bear market, once over, no matter how long or hard the fall, you will hear people say that they predicted the extent of the drop.  So now is a good time to ask yourself: do I know what’s going to happen tomorrow?  Or next week?  Or next month?  Is this a good time to buy or sell?  Does anybody seem to have a handle on what’s going to happen in the future?

Record your prediction, and any predictions you happen to run across, and pull them out a month or two from now.

Chances are, you’re like the rest of us.  Whatever happens will come as a surprise, and then look blindingly obvious in hindsight.  All we know is what has happened in the past.  Today’s market drop is nothing more than a data point on a chart that doesn’t, alas, extend into the future.

Markets have become very oversold, a market technical term that indicates that we've sold off too far too fast. That means a bounce is near, and it may be a big one. If you're worried about what the markets are doing, and overexposed on your risk, you should use these bounces to hedge your portfolio or sell some portions thereof to the "sleeping point"; that is, the point where you can sleep or get through your day without worrying about your portfolio declining. Think about putting some spare cash in the markets after you see some signs of the markets stabilizing, feeling good about picking them up on sale (disclaimer: this is not a recommendation to buy or sell any security).

For our clients, over the past several weeks, we have reduced market exposure through sales of certain positions, and have increased our hedges. But we are not preparing for an all-out bear market. In fact, we have been looking to pick up some positions that are much more attractive after this latest selloff. After all, the stock markets are still in an uptrend, the economy is hitting on all cylinders, and there are no signs of an impending recession.

If you are worried or would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://www.fool.com/knowledge-center/6-things-you-should-know-about-a-stock-market-corr.aspx

https://www.yardeni.com/pub/sp500corrbear.pdf

https://finance.yahoo.com/news/stocks-getting-smashed-143950261.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

A Strawberry Alarmist?

"Good sense, innocence, cripplin' mankind
Dead kings, many things I can't define
Occasions, persuasions clutter your mind
Incense and peppermints, the color of time

Who cares what games we choose?
Little to win, but nothin' to lose"

--- Song Lyrics from the 1967 hit single "Incense & Peppermints" written by Tim Gilbert & John S. Carter and performed by the group known as The Strawberry Alarm Clock

Suppose somebody came up to you and shouted: “I have terrible news about the economy. I think you should sell your stocks!”
Alarmed, you say: “Oh, my God. Tell me more!”
And this mysterious stranger shouts: “Run for the hills! The American economy just added 200,000 more jobs—more than expectations—and the U.S. jobless rate now stands at 4.1%, the lowest since 2000!”
You blink your eyes. So?
“There’s more,” you’re told. “The average hourly earnings of American workers have risen a more-than-expected 2.9% over a year earlier, the most since June of 2009! You should sell your stocks while you can!”

Chances are, you don’t find this alarmist stranger’s argument very persuasive, but then again, you don’t work on Wall Street. After hearing these benign government statistics, traders rushed for the exits from the opening bell to the closing on Friday, and at the end of the day the S&P 500 stocks are, in aggregate, worth 2.13% less than they were last Thursday. The NASDAQ Composite index fell 1.96% and the Dow Jones Industrial Average, a somewhat meaningless but well-known index, was down 2.54%.

To understand why, you need to follow some tortuous logic. According to the alarmist view, those extra 200,000 jobs might have pushed America one step closer to “maximum employment”—the very hard-to-define point where companies have trouble filling job openings, and therefore have to start offering higher wages. No, that’s not a terrible thing for most of us, but the idea is that if companies have to start paying more, then they’ll be able to put less in their pockets—and the rise in the hourly earnings of American workers totally confirmed the theory.

If you’re an alarmist, it gets worse. If American workers are getting paid more, then companies will start charging more for whatever they produce or do, which might raise the inflation rate. “Might” is the operative word here. There hasn’t been any sustained sign of higher inflation, which is still not as high as the Federal Reserve Board wants it to be. But if you’re a Wall Street trader who thinks the market is in a bubble phase, you aren’t necessarily looking at facts to confirm your beliefs.

Suppose you’re not an alarmist. Then you might notice that 18 states began the new year with higher minimum wages, which might have nudged up that hourly earnings figure that looked so alarming a second ago. And some companies have recently announced bonuses following the huge reduction in U.S. corporate tax rates, whose amortized amounts are also finding their way into wage statistics.

Meanwhile, those same government statistics are showing a resurgence in factory activity and a rebound in housing, which together, account for more than 50,000 of those new jobs.

So the question we all have to ask ourselves is: are we alarmists? Selling everything in anticipation of a bear market has never been a great strategy, even though stocks are admittedly still priced higher than they have been historically. Trimming some positions and perhaps putting on some hedges into one of the greatest bull runs of our time makes a lot of sense. But panicking never paid worthwhile benefits to anyone.

If you are not an alarmist, then you have something to celebrate. The S&P 500 has now officially ended its longest streak without a 3% drop in its history—as you can see from the below chart. It’s an historic run not likely to be seen by any of us again. The truth about the markets is that short, sharp pullbacks are inevitable and routine—unless you were living in the past year and a half, when we seemed to be immune from normal market behavior.

Although the drop on Friday was a bit "jarring", and technical indicators point to some internal deterioration, I don't believe that this is the start of a bear market. Employment, housing and the overall economic environment are way too strong to give way to a recession, at least not in the next six to nine months.

I've been saying for months now that the market is way past due for a normal correction, as evidenced by the above chart. A pullback of 10-15% in the markets would be normal and healthy, to allow this market to "rest up" for the next move higher. If you think you're nimble enough to get out of the markets now and know when to get back in to catch the next wave higher, then I and 90% of the masses out there can probably learn from you. But as the great fund legend Peter Lynch once said, "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” 

If you're concerned about the markets and you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:
https://www.bloomberg.com/news/articles/2018-02-02/u-s-added-200-000-jobs-in-january-wages-rise-most-since-2009

https://www.bloomberg.com/news/articles/2018-02-01/asia-stocks-to-slide-as-tech-stumbles-bonds-drop-markets-wrap?

https://www.theatlantic.com/business/archive/2018/02/market-dow-drop/552254/?utm_source=atltw

TheMoneyGeek thanks guest writer Bob Veres for his contribution to this post

Running for the Hills

I've never seen anything like it. The mere mention of Amazon eyeing another kind of business can send chills down traders' backs who might own stocks in that line of business. It seems no one wants to be caught owning the next business Amazon might want to conquer.

As a result, on Tuesday morning, Wall Street traders woke up to something they haven’t experienced much of lately: actual market volatility.  One trader posted an image of his Bloomberg terminal at the market opening, which showed an immediate scary-looking plunge in U.S. equities as the opening bell rung.  By the end of the day, American stocks were down more than one percent, the worst one-day loss since last August, and capping the largest two-day loss since last May. One percent! Oh the horror of a selloff.

What’s going on?  Are U.S. stocks really a full percentage point less valuable today than they were yesterday morning?

By the end of the day, it was clear that much of the drop came from a handful of U.S.-based healthcare companies, whose stocks had been unloaded by spooked traders.  Why?  There had been an announcement by Jeff Bezos of Amazon, Warren Buffett of Berkshire Hathaway and Jamie Dimon of JPMorgan Chase, Inc. that they were thinking about forming a new independent healthcare provider.  The market prices of these companies fell anywhere from 1.8% to 8.6% as a result of this new, still-hypothetical competition.  Collectively, these healthcare companies saw their total worth—measured by the value of shares outstanding—drop $30 billion in roughly two hours of trading.

Did this make sense?  Surely not.  Experienced stock pickers were basing their decision to sell, sell, sell on how Amazon totally disrupted retail investing. JPMorgan Chase has enormous financial clout and Warren Buffett is a legend in the investing world.  But the “plan” they announced was really more of an intention to create a plan, and it was uncertain whether the new disruptive high-tech healthcare provider would be available to mainstream Americans or just the employees of three very large companies that desperately want to reduce their health insurance costs.

It will be at least a year before we know what Bezos, Dimon and Buffett plan to create, if anything, and more years before any current healthcare provider is disrupted by their new model.  Healthcare companies have time to prepare for the competition, and meanwhile they should not be significantly less valuable one day over another, due to a vague announcement of a plan to do something.

The bigger lesson of the downturn is how easy it is to spook Wall Street traders these days.  With market valuations persistently higher than historical averages, traders seem to be jumping at shadows in hope of avoiding the next downturn.  The challenge they face is that nobody has a reliable way to predict the real thing before it happens.  Jumping at shadows just means, in many cases, running up trading costs and booking losses.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://qz.com/1192731/amazons-push-into-healthcare-just-cost-the-industry-30-billion-in-market-cap/

https://www.ft.com/content/3353179a-05d3-11e8-9650-9c0ad2d7c5b5

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

A 2018 Forecast to Bank On

Will the markets go up, go down, go sideways, and by how much? If you're like me, you're reading many of the forecasts that pundits publish this time of the year. So I decided to publish my own.

Before I get into my market forecast for 2018, I want you to consider why forecasts are so alluring to investors like ourselves. What is the force that influences us to make decisions based on forecasts? There is ample evidence that expert forecasts are correct only half of the time, yet we are still attracted to them. Why?

You may not be able to put your finger on it because our attraction to forecasts is largely subconscious. It boils down to how the brain likes to operate. Our brain is a planning machine; it finds much contentment and peace in being able to plan. When we don’t know what the future holds, we can’t plan with certainty. This bothers the brain. So it, subconsciously, seeks for some sort of certainty. And forecasts, especially confident ones, provide an illusion of certainty.

We are subconsciously attracted to forecasts even though we consciously recognize that forecasts historically have not been very accurate. We fix this problem by giving greater weight to forecasts that 1) confirm what we want to happen and 2) are more confident than others. But these don’t improve the accuracy, just our perception of accuracy.

My Forecast

I am quite confident in my forecast for 2018. To be fair, it was the same forecast I’ve had in prior years (though this is the first time I've actually published it), and will likely be the same forecast in future years. Why wouldn’t I keep it the same? It has an overall accuracy very close to 100%:

• The economy/market will do something that surprises us
• Investors who watch or look at the markets or their portfolio quite often will experience more stress and greater unhappiness than those that don’t
• No one will be able to predict what will happen perfectly, but it will all seem obvious in hindsight
• You will wish you owned more stocks if the markets are going up, and wish you were holding more cash if the markets are going down
• Your diversified portfolio’s return will not match the market’s return, will lag it in a rising market environment, and probably outperform it in a falling market environment (but you'll find cold comfort in an outperforming portfolio if it's still going down)
• The pain of missing out on bigger gains will outweigh the pain of bigger losses
• You will be tempted to abandon your plan at some point based on expert forecasts and/or short-term market performance
• Investors that focus on those things they can control (i.e. your reaction) will have a better investment experience than those that focus on what they can’t control nor predict (i.e. What’s XYZ going to do?)
• Investors who abandon their plan to chase a “winning investment” or “sure thing” will have lower long-term returns than investors who stick with their plan

You may be frustrated that my forecast doesn’t say anything about where the market will go or what sector to invest in. If so, then I’m sorry to disappoint you. But understand that in my 30+ years advising clients, I have learned that the best results are obtained by those who have the discipline to ignore the distractions and stick with the plan we have developed.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

I wish you all a prosperous, fulfilling, happy and healthy 2018.  Thank you for allowing me to be your trusted partner along the journey.

Source: Information provided by The Emotional Investor, a Member of The Behavioral Finance Network. Used with permission.

Is A Donor Advised Fund Right for You?

Executive Summary: Setting up a Donor Advised Fund (DAF) and front loading charitable deductions can save you thousands of dollars in taxes immediately, while directing distribution to charities in/for future years. Even if you decide not to establish a DAF, you should consider whether accelerating the coming years' charitable contributions to this year makes sense for you, especially if you are phased out of itemizing deductions starting the next year.

As you've heard by now, President Donald Trump has signed the Tax and Jobs Act of 2017, which mostly makes sweeping changes to tax rates and eliminates many deductions starting in 2018. For most households, this means no itemized deductions due to an increased standard deduction ($12,000 for single, $24,000 for married), a limit on the deduction of taxes ($10,000 of income, sales and property taxes combined) and elimination of most miscellaneous itemized deductions.

Many of you give generously to charities every year regardless of the prospect of deducting those contributions. While the changes to the deductiblity of contributions is little changed, the fact that you likely won't be able to itemize, means that you'll receive no tax benefit going forward if your contributions plus other itemized deductions don't exceed your standard deduction.

This means that 2017 may be a year that you'll want to consider a Donor Advised Fund (DAF) to take advantage of what might be your last year for itemizing, and take a large 2017 deduction for your contribution. The deadline for establishing a DAF is December 31, 2017, though for all intents and purposes, December 29 is the last business day of the year and may be the true deadline.  Of course, you can consider one for 2018 and future years.

A DAF is simply an account that you establish with the charitable entity of a well-known custodian (Schwab, Fidelity, Vanguard or TD Ameritrade for example) and to which you make a lump sum contribution to fund future years' contributions. For example, if you give $2,000 a year to charity, you could fund it with $10,000 today, and direct $2,000 a year to your charities each year while the fund grows tax free. Better yet, if you fund the DAF with long-term appreciated stocks or funds, you'll get a full deduction for the fair market value of the securities, and never have to report the capital gain on your tax return.

This is right for you if:

1. You're willing and able to irrevocably contribute at least $5,000 (some custodians have higher minimums) to a managed account where you direct future contributions to the charities of your choice;
2. You expect to be phased out of itemized deductions starting in 2018 due to the increased standard deduction and other changes to itemized deductions (see above) or,
3. You would benefit more from an acceleration of charitable deductions to this year (than in future years) due to high income or lower tax rates in the years ahead.

Even if you decide not to establish a DAF, you should consider whether accelerating the coming years' charitable contributions to this year makes sense for you.

The most common ‘strategy’ for creating a donor-advised fund is relatively straightforward – donor-advised funds are a good fit any time there’s a desire to contribute (and get the tax deduction) now, but make the actual grant to the final charity at some later date. In fact, the whole point of a donor-advised fund is to separate the timing of when the tax deduction occurs from when the charity ultimately receives the money.

Once established, you can add funds to a DAF in future years, and you can take as long as you want to distribute the funds to various charities. Some custodians maintain minimum donations you can make to a charity at any one time, say $50.

The important caveat to remember in all donor-advised fund strategies is that once funds go to the donor-advised fund, they must go to some charity, and cannot be retracted for the donor. The charitable gift to a donor-advised fund is still irrevocable, even if the assets have not yet passed through to the underlying charity. Nonetheless, for those who are ready to make the charitable donation – and want to receive the tax deduction now – the donor-advised fund serves as a useful vehicle to execute charitable giving strategies over time. And it certainly doesn’t hurt that any growth along the way will ultimately accrue tax-free for the charity as well.

If you would like to review your current investment portfolio or discuss setting up a Donor Advised Fund, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.