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April Financial Focus: The Return of Volatility

| April 10, 2018
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Welcome to April!  It is hard to believe that Spring has finally sprung!  Snow has raised its ugly head again twice in Central Virginia while the pollen count is continuing to climb.   Like the weather the markets seem to have a mind of their own or is it perhaps just that the markets are behaving more normally than they have in the past several years?

Last year, stocks marched higher with only minor pullbacks. When the year ended, the largest peak to trough decline for the S&P 500 Index was just under 3% (St. Louis Federal Reserve data on the S&P 500). It was a year that lacked turbulence and one that rewarded diversified investors.  Since the beginning of February, volatility has returned. It’s a reminder that periods of relative tranquility don’t last forever.  

 In my opinion, it’s something that the long-term investor should look past, though I recognize it can create uneasiness among some investors.  If we were facing serious economic problems, something that might be signaling a recession, it would be a cause for concern. Right now, I don’t believe we are.

Let’s review two underlying supports for equities.  Thanks in part to the tax cut, corporate profits are forecast to rise nearly 20% this year (Thomson Reuters).   Weekly first-time claims for unemployment insurance recently touched a level not seen since the late 1960s (St. Louis Federal Reserve). It’s a concrete sign that companies don’t want to lose employees. If business conditions were deteriorating, the opposite would be true.

The Conference Board’s Leading Economic Index (designed to detect emerging trends in the economy), just hit a new high. I know we are facing some challenges (we always will), but the economic fundamentals are solid right now.  Coupled with rates that remain at historically low levels, the fundamentals have cushioned the downside, in my view, and remain supportive of shares.

Shorter term, however, headline risk continues to whipsaw sentiment.  Since volatility has returned it is more important than ever that we remember that this is closer to "normal" market behavior than what we saw last year.

Causes of volatility

There are however a couple of things that that have stirred up volatility, in my view. 

Last month the administration announced steep tariffs on steel and aluminum imports, fueling concerns over protectionism and the potential impact on the economy.  This caused the markets to react and one of the results of that reaction is increased volatility as the markets try to price in the new information.  Aw we saw in the past couple of weeks, the back and forth nature of imposing tariffs has injected uncertainty into the market and we all know how much the market hates uncertainty!

Investors viewed the corporate tax cut and the paring back of regulations favorably. Most economists support free trade. It’s a net benefit to the U.S. and global economy. But “net benefit” means there are both winners and losers.

Losers–those whose jobs disappear amid access to cheaper imports. Winners–consumers who pay less for various goods, and those who work in export-oriented industries. In 2017, U.S. exports totaled $2.3 trillion (U.S. Bureau of Economic Analysis). Yes, that’s trillion with a “T.”

So, what we have is the tension of "Free Trade" versus "Fair Trade".  Believe me this is a highly debated topic. Talk to any two experts and they are likely to have widely divergent opinions on this topic.  

As you know U.S. manufacturers are consumers of steel and aluminum, including farm and construction equipment, aerospace, and pipelines and drilling equipment in the energy industry.  So, an increase in the cost of imported material may have the result of forcing costs higher which in turn could push prices higher for the consumer of our finished products.  At the margin, it may modestly boost inflation and could force some U.S. manufacturers to put projects back on the shelf or move production offshore.

Additionally, as we have seen in the past week or two, U.S. tariffs may invite retaliation, pressuring exporters, jobs and profits in globally competitive sectors. It could also spark a tit-for-tat trade war that hurts everyone.  As March ended, the administration announced a new set of tariffs on Chinese imports. In return, China announced new barriers to some U.S. goods, though the response was measured.  With each announcement the markets reacted (even though no tariffs have actually been charged as of this writing!).  Remember, as I already mentioned, the markets hate uncertainty!

In addition to the back and forth of all this, troubles popping up in the tech sector have also added to volatility. For example, Facebook is embroiled in a controversy over privacy and data sharing. More recently, Amazon has come under fire as well.  Yes, they are only two stocks, but both have performed admirably, leading the tech sector higher. And, they have a combined market capitalization of $1.1 trillion (WSJ as/of 4.3.18).

Perspective

I provided an explanation for the recent volatility because I believe one is in order, however, let me caution you not to get lost in the weeds. Day traders care about minute-by-minute swings in stocks prices. Long-term investors sidestep such concerns.  So, let’s step back and gather some perspective by reviewing the data.

According to LPL Research—

  • The average intra-year pullback (peak to trough) for the S&P 500 Index since 1980 has been 13.7%.
  • Half of all years had a correction of at least 10%.
  • Thirteen of the 19 years that experienced an official correction (10% or more) finished higher on the year.
  • The average total return for the S&P 500 during a year with a correction was 7.2%.

These bullet points are an evidenced-based way of saying turbulence surfaces from time to time. Patient investors who don’t react emotionally have historically been rewarded.  I understand that some degree of risk is inevitable. But our recommendations are designed to minimize risk, and they are designed with your long-term goals in mind.

Table 1: Key Index Returns

 

 

                                                   MTD %      YTD %       3-yr* %

Dow Jones Industrial Average     -3.7           -2.5            10.8

NASDAQ Composite                    -2.9            2.3             13.0

S&P 500 Index                              -2.7           -1.2              8.6

Russell 2000 Index                         1.1           -0.4              7.2

MSCI World ex-USA**                   -2.2           -2.7              2.5

MSCI Emerging Markets**             -2.0            1.1              6.3

Bloomberg Barclays US

Aggregate Bond TR                        0.6            -1.5             1.2

 

 

Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar

MTD returns: Feb. 28, 2018-Mar. 29, 2018

YTD returns: Dec. 29, 2017-Mar. 29, 2018

MSCI returns run through Mar. 30, 2018

*Annualized

**in US dollars

Attaining goals

Speaking of goals, I'd like to take some time to talk about goals and why I believe they are important to your long term financial well-being and some of the tools I have that you can take advantage of.

A study of goals was allegedly conducted on a graduating class from Harvard in the 1950s. Supposedly, only 3% had written goals, and it wasn’t long before they controlled over 90% of the class’s wealth. 

Maybe you’ve heard the story, maybe not?  It may or may not be true, but goals are important because they give us clarity and purpose– something to accomplish. Sometimes, goals require us to step outside our comfort zone, but they have to be realistic and attainable.

 Have you ever sat down to set goals? Looking at a blank screen or blank piece of paper sometimes gives us the feeling that what we’re trying to accomplish is insurmountable. Or, we come up with something that’s too vague.

There are many compartments within life that benefit from goal-setting–career, family, personal, and health. As someone who advises you on financial matters, one of my goals is to help you uncover your financial goals. And–this is important–create a plan that will put you on a path toward your goals.

Remember, the goal is your destination. Once we have the destination in mind, we need a roadmap that will get us there.  Savings, specific purchases, and retirement come up often. But these require what might be called “delayed gratification.” You may have to give up something today to achieve a specific result tomorrow.   While we can make our money work for us, i.e., compounding, savings may require choices between wants today and needs tomorrow.

Let’s start with the basics–budgeting, or what I call a spending plan. Especially for those in transition, this can become an important financial lifeline.  Unfortunately, too many folks quickly jot down a budget, place it in a drawer, and forget it.

Instead, take time and customize it to your personal situation. Whether you prefer working on a spreadsheet or in the online space, I have tools I can provide you.  As my client you have full access to a full-service state of the art online financial management application.  If you have not checked it out recently let me know and will send you the information you need to access this powerful tool.  Catherine and I share responsibilities for developing and maintaining our family spending plan.  I highly recommend that you do the same.   The application will help you categorize and track your monthly spend automatically.

If you prefer working with spreadsheets, just drop me a note and I can provide you a suite of spreadsheets I have developed that you can use to the same result.  The method you use to establish your plan is not nearly as important as that you establish a plan and then monitor and revise it as you need to.

So, what are your goals? For some of my clients (especially when we first start working together!) the overriding goal is: “money at the end of the month” rather than “month at the end of the money”!  While that is admirable, I feel we can get more specific. 

Remember that to build a nest egg, one needs to do several things.  First as I have already mentioned, an assessment of where we are today has to happen.  That assessment may provide insight into spending patterns that are easy to adjust, or it may provide insight into issues that need more work.

For us to build wealth we need to reduce or eliminate debt, have ready access to cash reserves in case of a financial emergency and ideally, we need to spend less than we earn on a consistent basis.  Home repair, auto repair, or health care expenses can pop up when you least anticipate them. If you have funds earmarked for the unexpected, the outflow for life’s little surprises are much easier to manage.

Once these basic things are accomplished then we can start to put more money into tax advantaged vehicles such as 401K plans, IRAs or other employer sponsored retirement plans.  For those who are self-employed, it’s important to begin contributing to a retirement vehicle that best fits your needs. I know that options sometimes breed complexity. But that’s what I’m here for–to help you navigate the murky waters.

Bottom line

Saving for the future takes discipline, but it doesn’t have to be a hard slog. Progress toward your goals creates its own sense of accomplishment and satisfaction.   But let’s add a nice carrot. As you reach smaller milestones, reward yourself along the way! It can be anything from a nice dinner out to an inexpensive weekend getaway during the off-season.

More importantly, get started. And please let me know how I may assist you.  I hope you’ve found this review to be educational and helpful. If you have any concerns or questions, let me say this one more time–please feel free to reach out to me. That’s what I’m here for.  Kind Regards, Rudy

PS:  If you are not taking advantage of the tools I can provide you and want to make better progress towards your financial goals, please call or email me! 

 

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