Category: Newsletter

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Newsletter Summary

• “How much can I make in this investment?” and “How much can I lose in this investment?” are perspectives that always need to be weighed relative to one another.
• Large divergences in the performance of U.S. large-cap v. small-cap stocks, growth v. value stocks and U.S. v emerging markets stocks have gapped even wider this year.
• The path of the economy is highly dependent on the pandemic, fiscal stimulus, unemployment and the election. All of which have a wide range of potential outcomes.

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Newsletter Summary

• The impact of Fed liquidity on sentiment in the second quarter was staggering and it has opened some amazingly wide gaps among sub-asset classes. Our research work lists are full.
• PE ratios tend to have a rather weak correlation to future stock prices over the short-term, but become a much more constructive tool to project return environments over longer periods.
• While some economic data suggests a rebound is underway, analyst forecasts for Q2 economic growth range from -33% to -40%, which are numbers we never expected to see in our lifetimes.

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Newsletter Summary

• From a high level, we are always focused on a few key items: economic growth, interest rates and earnings. We believe that with an understanding of changes in those key variables we can develop a solid foundation for asset allocation decisions and fundamental investment decisions.
• We never try to be surgical with the timing of our investment decisions. We believe that if we can be directionally correct on a consistent basis it improves the odds of long-term wealth compounding for clients.
• The beginning of 2020 has been a historically unique period for individuals, businesses and financial markets. As we navigate the environment we are distilling our research down to the things we can control and positioning portfolios accordingly.

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Section Summary

• Market Notes – Equity and fixed income markets broadly moved higher during the fourth quarter, primarily driven by an accommodative U.S. Federal Reserve and signs of progress in the U.S. and China trade spat. On the economic front, news was mixed, but most investors focused on strong U.S. consumer data that they hoped would prop up tepid U.S. GDP growth and overcome softness in the U.S. manufacturing sector.
• Equity & Fixed Income Comments – Our portfolio positioning in the equity and fixed income components of client portfolios continues to reflect our relatively cautious outlook for U.S. equities and U.S. corporate bonds. The broad rally left us with few opportunities to be active searching for value. On the equity side, two areas that we have not increased investment yet, but are patiently waiting for more attractive entry points are U.S. value stocks and U.S. small-cap stocks. Within fixed income, we continue to like the higher quality and non-cyclical parts of the credit markets and favor securitized assets, mortgage-backed securities, insurance-linked securities and emerging market debt.
• Research Focus – At the end of 2019, Congress quietly passed the SECURE Act, which ushered in the largest retirement planning law changes in over a decade. It is intended to strengthen retirement planning for all Americans. The Act has a number of relevant implications for investors.
• Client Focus – Over our careers we have learned that market catalysts are almost always discussed with certainty in hindsight even though they were often unpredictable before they occurred. How can catalysts be accounted for when making investing decisions?

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Section Summary

• Market Notes – Markets were somewhat of a roller coaster in the third quarter as threats and reconciliation around trade impacted investor sentiment. In addition, investors remained highly sensitive to announcements from the U.S. Federal Reserve around interest rates and the pace of corporate earnings growth. The uncertainty was balanced by still low unemployment levels, which have fueled consumer spending growth.
• Equity & Fixed Income Comments – Our portfolio positioning in the equity and fixed income components of client portfolios continues to reflect our relatively cautious outlook for U.S. equities and U.S. corporate bonds. On the equity side, we remain heavily invested in high quality (companies with strong balance sheets) U.S. large-cap companies, with an added emphasis on the real estate sector and companies that have consistently grown their dividends. During the quarter, we also became slightly less aggressive in foreign markets as we shifted exposure away from Asia (notably China). Within fixed income, our emphasis remains on the high quality, non-cyclical parts of the credit markets. In municipal markets we favor investments in the private and direct origination markets.
• Research Focus – There are generally four stages in a business cycle: early-cycle, mid-cycle, late-cycle and recession. We believe it is important to have a view on where the U.S. (and other countries) reside in the business cycle because different asset classes and sub-asset classes perform better (worse) during the various stages. If we are confident in our estimation of the business cycle phase, we may be able to emphasize or de-emphasize certain areas of the market in client portfolios.
• Client Focus – We are highly practical about the execution necessary to include certain asset classes in client portfolios and skeptical of the value in the complexity that many asset classes bring. We are not averse to owning any asset class in client portfolios. They just need to meet our cost, liquidity and risk-adjusted return hurdles for consideration.

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Section Summary

• Market Notes – Markets were broadly positive in the second quarter, but fairly volatile month-to-month. The key factors driving market activity were anxiety over trade tensions and optimism that the Fed would cut interest rates to support the economy.
• Equity & Fixed Income Comments – Our portfolio positioning in the equity and fixed income components of client portfolios reflects our relatively cautious outlook for U.S. equities and U.S. corporate bonds. On the equity side, we made an investment in a mutual fund whose mandate is to invest in companies that have a history of growing dividends. In fixed income, our emphasis continues to be on the higher quality and non-cyclical parts of the credit markets. We like emerging market bonds, securitized assets, mortgage-backed securities, insurance-linked securities and infrastructure debt.
• Research Focus – We have found relatively few investment opportunities among smaller domestic companies, primarily because of where we believe we reside in the economic cycle. However, the story is much different among foreign small- and mid-cap companies. We believe foreign small caps have a number of attractive characteristics that make them an appropriate piece of a client’s long-term equity portfolio.
• Client Focus – One of the key inputs to asset allocation planning for clients is capital market assumptions. What are each of the asset classes being used in client portfolios expected to return? Looking back at historical market returns can be easy for some advisors to do, but we believe those numbers set inappropriate expectations. We think looking forward sets more rational expectations.

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Section Summary

• Market Notes – Early in the quarter (January 4) Fed Chairman Jerome Powell stressed that the Fed would not hesitate to respond with all tools necessary to counteract an economic downturn or increased turmoil in financial markets. As a result of the about-face by the Fed, many areas of the financial markets that had posted significant losses in the fourth quarter of last year, rebounded strongly in the first quarter.
• Equity & Fixed Income Comments – Our portfolio positioning in the equity component of client portfolios reflects our relatively cautious outlook for U.S. equities at the sub-asset class level. We have tilted portfolios towards large-capitalization stocks and value-oriented stocks (including REITs). We also continue to like emerging markets equities where the short-term picture showed signs of improvement in the first quarter. Fixed income investments are positioned for our expectation of yield curve flattening and client portfolios are now generally about neutral duration. We continue to expect corporate credit to underperform. Within corporate credit, we prefer short maturity bonds from high quality issuers.
• Research Focus – An inverted yield curve occurs when the 2-year Treasury yield is higher than the 10-year yield. This happens when the market believes growth will be lower than the change in Fed policy rates. An inverted yield curve is often referred to as a ‘canary in the economic coal mine’, due to its accuracy in predicting upcoming recessions. We discuss the yield curve and what it tells us today.
• Client Focus – Home Country Bias is the natural tendency for investors to be most attracted to investments in domestic markets. For U.S.-based investors this means having a disproportionately large allocation to investments in the U.S. This bias can limit the investing opportunity set and reduce diversification.

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Section Summary

• Market Notes – Fourth quarter returns across all global equity markets were broadly weak. Conversely, fixed income markets generally held up well. A combination of factors drove the volatility in equity markets, but slowing economic growth, concerns about future profit growth and interest rate uncertainty highlighted the list.
• Equity & Fixed Income Comments – Our portfolio positioning in the equity component of client portfolios has been focused on bolstering the resilience of our U.S. investments given what we perceive to be elevated risks over the short- to intermediate-term. Fixed income investments are positioned for our expectation of yield curve flattening and to take advantage of opportunities outside of corporate credit with better risk-adjusted value. Across all asset classes we generally favor active management to passive at this point in the economic cycle.
• Research Focus – Corrections. How often do they happen? How to counter the emotional reactions that tend to accompany short-term market volatility?
• Client Focus – Market timing requires two largely perfect decisions to be successful – when to sell before the market goes down and when to buy before the market goes back up (or vice versa). We review the impact of getting those decisions wrong.

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Section Summary

• Opportunity & Nerve – If we can assess the valuation opportunity of investment alternatives with discipline, nerve is replaced with trust in our work.
• Market Notes – Returns across asset classes diverged considerably in the third quarter, continuing a trend building throughout the year, as emerging market pressures intensified and interest rates pushed higher while corporate earnings growth remained strong.
• Equity & Fixed Income Comments – For the most part, our broad portfolio positioning in the equity and fixed income components of client portfolios is unchanged. We are conducting detailed research on real estate and closed-end fund opportunities as we believe both areas could offer intermediate- to long-term return potential in client portfolios. Our work may or may not result in investments, but the current investing environment has generated interest in both areas.
• Research Focus – A review of diversification. Diversification can reduce portfolio volatility and may assist in modifying behavior – specifically overconfidence in an ability to “outsmart” the market.
• Client Focus – The Global Industry Classification Standards (GICS) recently implemented the largest revision to its methodology in its 19-year history. Roughly 2,100 companies were impacted globally as the evolution of many business models resulted in the introduction of a Communication Services sector.

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Section Summary

• Decisions – Is it transitory or secular? The hardest decisions we make as investors are the ones we make when things don’t go perfectly.
• Market Notes – Returns across asset classes varied considerably during the second quarter as a strong U.S. dollar, fear of trade wars, weakness in emerging markets, political instability in Europe, strong U.S. corporate earnings growth and improved U.S. economic growth left markets uncertain about future direction.
• Equity & Fixed Income Comments – Within our foreign equity allocations we have spent considerable time reviewing our emerging market investments and remain confident in our position over the intermediate-term, but expect further volatility in the short run. In U.S. equity markets, we have begun to bias our research efforts to value opportunities, but are currently roughly style neutral. On the fixed income side we have less interest rate exposure than our benchmarks, remain underweight corporate credit and are using active management in areas of the market we are finding value. We continue to de-emphasize passive mutual funds and ETFs.
• Research Focus – Performance swings, emerging markets and the negative impact of behavioral biases.
• Client Focus – Less is More. A quick look at losing less or gaining more and which is more valuable to long-term wealth compounding.