Nola Kulig
Kulig Financial Advisors
Longmeadow, MA, 01116 USA
413-565-2839
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2017 Q3 Market Review: Markets Continue to Rise Despite Geopolitical Turmoil and Natural Disasters

November 1st, 2017

This is our review of the markets for third quarter and year-to-date 2017. Long term readers know that we do not believe in making forecasts, instead commenting on cross currents influencing the markets. As usual, our goal is to look at recent market results, put them in perspective, and see how that experience should set our expectations going forward.

We look at the following topics:

  • 2017 Q3 and Year-to-Date Markets Review
    • Summary of Returns
    • What Does all This Mean?
  • Conclusion

2017 Q3 and Year-to-Date Market Review

Summary of Returns

The S&P 500 Index finished the quarter at a record high. Notably, the closely followed gauge of 500 large U.S. stocks ran up its quarterly winning streak to eight consecutive quarters (MarketWatch data http://www.marketwatch.com/story/us-stocks-set-for-weaker-open-but-monthly-gains-set-to-remain-intact-2017-09-29).

It’s done so in the face of three devastating hurricanes—Harvey, Irma and Maria, dysfunction in Washington, unsettling news from North Korea, and gridlock in Washington.

But in many respects, it shouldn’t be all that surprising; economic fundamentals are actually supportive of good stock performance.

Stocks take their longer-term marching orders from corporate profit growth. And profits are driven primarily by economic growth at home and abroad.

Currently, we’re in the midst of a synchronized global expansion, which has created a strong tailwind for earnings.

Moreover, interest rates remain near historic lows, and the Federal Reserve hasn’t been shy about signaling that any rate hikes are expected to come at a gradual pace.

If I had to concoct a recipe for bull market, I’d go heavy on profits, economic growth, and low interest rates—Oh, wait a minute—that’s today’s environment!

The markets focus on these factors to the exclusion of nearly everything else, like the massive damage to lives and property in Texas, Florida, and Puerto Rico. Short term, the economic data is taking a hit from the storms. Longer term, the markets are saying it is unlikely to have much impact on the economic trajectory. (Please note that some of your dollars were donated from Kulig Financial Advisor’s profits and were matched by TD Ameritrade, your custodian if you have ongoing investment services with us.)

While North Korea’s quest for an ICBM that can strike the U.S. is also very unsettling, short-term investors seem to be pricing in the unpredictability of the rogue regime. More importantly—speaking strictly from an investment perspective—investors aren’t anticipating a disruption in the economic cycle.

So, while we should be prepared for more troubling news, it simply isn’t affecting U.S. economic activity.

 

Market Returns

Market

Index

September

Q3 2017

YTD 2017

Stocks        
Large Cap S&P 500 Index

0.3%

3.0%

11.9%

Midcap S&P Midcap

-1.5

0.9

5.3

Small Cap S&P Small Cap

-2.6

1.3

1.1

Non-US Developed Markets MSCI EAFE

0.0

2.7

17.1

Emerging Markets MSCI Emerging Mkts.

2.2

9.4

28.3

US Bonds Bloomberg Barclays US Aggregate

0.9

1.2

3.6

REITs S&P US REIT

-0.4

3.1

2.8

MLPs Alerian MLP

-4.9

-4.3

-6.3

Gold S&P GSCI Gold Sub index Total Return        -2.8 3.0 10.7
Commodities S&P Dow Jones Commodity Index TR

3.3

7.2

-3.8

Sources: AJO Partners, Factset, S&P Dow Jones Indexes

What Does All This Mean?

Many of you have asked if the steady climb upward in stocks and their accompanying high values mean it is time to take some risk off of portfolios. This is an excellent question, and while we have discussed what this means for individual portfolios, it provides an opportunity to discuss our investment philosophy.

If we (meaning both you and Kulig Financial Advisors) have properly assessed risk tolerance and capacity when the portfolio was built, and done some other planning, then we shouldn’t need to make radical changes to your portfolio for several reasons:

  • If you have followed our counsel, those still working have sufficient emergency reserves and insurance in place; if you are retired, you have either sources of guaranteed income (like pensions and Social Security) or cash to cover several years’ expenses. If that is the case, then your longer term portfolio truly is for more discretionary expenses, and a market decline won’t impact your ability to keep the lights on or put food on the table.
  • We believe it is extremely difficult to predict future market direction, and the only real option anyone has is to maintain a carefully selected risk level for a portfolio. With the stock market mostly up since the 2008 crash, it would have been easy to say that stocks were highly valued for a while and that it was time to get out. With hindsight, that would have been a mistake.
  • While we don’t believe in market timing, we do favor rebalancing to your target allocation for stocks and all other assets. Those of you who have assets managed or advised on by us have in fact been taking profits out of stocks and placing them in lower risk or lower priced assets. In some cases this meant buying international stock markets which were underweighted and which have lower stock values. For others, it has meant buying bonds from time to time. The re-allocations depended on the starting positions for each portfolio. Again, these changes were guided by your asset allocation, not a short term forecast of a US stock market decline.

We hope this puts risk in a perspective that takes into account your individual financial situation and portfolio design. Those are the major reasons to make changes to portfolios, and they do not change that often.

Conclusion

We would reiterate to make sure you are at your recommended risk level and asset allocation for your portfolio. If you are, then all is well, and you can focus your attention elsewhere. If not, please make adjustments so that you are. And last but not least, if you are not sure, please call and let’s see where you need to be.

Thank you very much for your trust and confidence.

 

2016 Q4 Market Review: A Year of Thwarted Forecasts

January 23rd, 2017

This is our review of the markets for fourth quarter and year of 2016. As you know, we do not believe in making forecasts, but we comment on cross currents influencing the markets. As usual, our goal is to look at recent market results, put them in perspective, and see how that experience should set our expectations going forward.

We look at the following topics:

  • 2016 Q4 and Year-to-Date Markets Review
    • Summary of Returns
    • The Markets’ Twists and Turns in 2016
  • What Does all This Mean?
  • Conclusion

2016 Q4 and Year-to-Date Market Review

Summary of Returns

As I write this review of the markets in 2016, some trends from the fourth quarter are already waning. Nonetheless, looking at what we experienced last year may be instructive as we look at the year ahead.

Last year was a tough one for prognosticators and strategists. There were so many twists and turns from a macroeconomic and political perspective that many experts, pollsters and forecasters had their hands full. Those activities are usually fraught with peril, as the error rate is high, but last year seemed worse than usual.

By now, it is old news how wrong the experts were about Brexit and the US election outcome. Not only that, but if they managed to call the Trump victory correctly, they usually got the market’s reaction wrong. Rather than nose diving, the stock market took off and headed for record territory.

Some additional observations from the table of returns, which follows:

  • The 12-month return for the S&P 500 Index of 12.0% was well above the long-term historical average since 1926 of 10.1%
  • In the US, small cap companies led the way, followed by medium-sized companies.
  • Style indexes are not shown, but value trumped growth (pun intended).
  • Emerging markets did well for the year, despite declining after Trump’s election win.
  • Developed markets outside the US rebounded in the fourth quarter, but still turned in a poor year.
  • High quality bonds did poorly, based on an outlook of increasing rates.
  • US Real estate investment trusts (REITs) did surprisingly well, considering their higher yielding nature and a consensus outlook for higher rates.
  • Master limited partnerships continued to benefit from both a firming in energy prices and investors’ hunt for income.
  • Commodities in general did well, with a firming US economy and an emerging consensus of further growth and firming inflation.
  • Despite declining in the fourth quarter, gold held onto positive results for the year.
Market Returns
Market Index December Q4 2016 2016
Stocks        
Large Cap S&P 500 Index 2.0% 3.8% 12.0%
Midcap S&P Midcap 2.2 7.4 20.7
Small Cap S&P Small Cap 3.4 11.1 26.6
Non-US Developed Markets MSCI EAFE 3.4 -0.7 1.0
Emerging Markets MSCI Emerging Mkts. 0.2 -4.2 11.2
US Bonds Bloomberg Barclays US Aggregate 0.1 -3.0 2.7
REITs S&P US REIT 4.7 -3.0 8.5
MLPs Alerian MLP 4.4 2.0 18.3
Gold S&P GSCI Gold Sub index Total Return -1.9 -12.7 7.8
Commodities S&P Dow Jones Commodity Index TR 1.3 3.8 13.3

Sources: AJO Partners, Factset, S&P Dow Jones Indexes

The Markets’ Twists and Turns in 2016

When we see the extremely strong finish for stock markets in 2016, it is worth recalling that it started out in a very rocky fashion, with comparisons to 2008 that were too numerous to count.

Markets later had to deal with the UK’s decision on whether to stay in the European Union. Pollsters predicted the country would remain, but instead we got Brexit, which is still a long-term proposition in terms of its eventual impact. We counseled maintaining your asset allocation through this period, and not making any brash moves. While the markets initially reacted strongly, once they got over the shock, they began to function normally again.

In fact, in the months leading up to the November US presidential election central bank policy produced considerable calm in the markets. In our last quarterly review, we questioned how long the “eerie calm” could last, as an environment where trading volume is low and most asset classes rise together cannot go on indefinitely. But it is impossible to forecast when and how it might end.

When it did end, it was fortunately to the upside. When Donald Trump won the election, stock markets initially lurched downward. Then they turned sharply upward, and the rest, as they say, is history. A consensus view emerged that Trump policies of infrastructure spending, reduced regulation and tax reform would kick start the US economy out of the low growth rate it has experienced since the Great Recession. Rather than deflation, we might need to focus on the potential for inflation, and with it, higher interest rates. The focus moved decidedly from Fed watching to Trump watching.

The only problem with this consensus view is that we aren’t there yet. As I write, Trump will be taking office in a few days, his cabinet still needs approval, and he has already had to revise some policies. Since we have a democratic government, his proposals will be subject to considerable debate, even though we have a Republican majority in both houses and a Republican president. In just the last week, the “Trump trade” has begun to recede, as markets got ahead of themselves. While we may ultimately get to where Trump wants us, the markets may have already fully priced most of that scenario into asset values.

What Does All This Mean?

The unpredictability of last year was a textbook example of why investors need fully diversified portfolios. If one had taken forecasters seriously, a lot of money could have been left on the table or outright losses experienced.

For example, a prospect (now client) came to see me in November, just prior to the election. He was getting to know several advisors as part of his selection process. One had recommended that the client liquidate a good portion of his portfolio on the supposition that if Trump won, it would negatively impact the markets. What did I think?

Long term readers of this newsletter and clients already know how I responded. Extreme changes in your asset allocation are rarely warranted, if you have carefully selected it based not only on your aptitude for risk, but as important, your capacity to bear risk.

Moreover, forecasting in general has a low batting average, especially in the political or macroeconomic realm. These are very difficult issues to fully analyze and get right. Not only that, but one can construct a completely cogent and thorough analysis and yet misread what market consensus really is, or how much is in asset prices.

I responded that the advisor in question could possibly be correct, but there was an equal chance he could be wrong. So to make an extreme change in a portfolio with no hedge in case of a potentially faulty forecast is a risky approach. If there is one thing I have learned, it is how often the markets can fool us. Also, we should avoid building what might be called a “single scenario” portfolio—one that has to have a specific set of conditions met for it to be correct. Instead, it should be as much as possible an “all weather” portfolio, with components that will help it weather different types of markets, since we can never really be certain in advance what may come our way.

So my new client did not liquidate most of his portfolio and is better off for it. We did, however, make some other adjustments based on his unique needs and circumstances.

Conclusion

Last quarter, we noted in that we expected volatility to rise as markets sort things out. Factors contributing to that view were that we were in an election year where the race was hotly contested, and there was some uncertainty regarding Federal Reserve policy.

Now that the election is behind us, things look no more certain than they did last year, despite the market’s reaction to the Trump victory. Now we will really see what the new administration can do, how the economy will fare, what the Fed will do, etc. And let’s not forget factors outside the US—the state of China’s economy, rising nationalism in Europe, and central bank policy outside the US.

Need I say more to make the case for a diversified portfolio?

We would reiterate to make sure you are at your recommended risk level and asset allocation for your portfolio. If you are, then all is well, and you can focus your attention elsewhere. If not, please make adjustments so that you are. And last but not least, if you are not sure, please call and let’s see where you need to be.

Thank you very much for your trust and confidence. We look forward to working with you in 2017. Happy New Year!

Election Year Upset: The Trump Effect on Markets

November 27th, 2016

I find that once again, rather than writing on the idea of financial plenty, thankfulness for that abundance and charitable giving, events in Washington, D.C. dictate that I discuss other topics. Last year, it was the impact of a Congressional budget deal on Social Security claiming strategies. This year, it is of course, the election results and the market’s reaction.

This month’s post looks at the following topics:

  • A Trump presidency and its potential impact on:
    • Government spending and inflation
    • The markets
    • Your portfolio
  • Charitable Giving
  • Kulig Financial’s Holiday Schedule

Potential Ramifications of a Trump Presidency

Many of you have asked me what, if anything, to do differently with your portfolios in an election year. Those questions came before the election, and I responded that if you had a portfolio risk level that was right for you, then you did not need to do anything differently. That risk level should take into account poor markets, if they occur, for whatever reason. As you know, I also believe that it is impossible to time markets—i.e., make short term tactical moves, consistently successfully. It is very easy to make investment mistakes, and there have not been many (any?) investors shown to consistently get that right.

What prompted those questions were prognostications by market “experts” who pounded the table for exiting the market just prior to the election. I do not know what they were recommending after the election, or what signposts they would be looking for to re-enter the market.

I am also not sure which candidate they all expected to win. If it was Trump, their forecasts were right for exactly one day, as the market plunged. But then it turned completely around the following day, erasing the previous losses and then some for a total gain of 1200 points for the Dow Jones average.

The bond markets were also volatile. During the stock market decline, US Treasury yields plunged, with the 10-year note falling 17 basis points, then climbing 37 basis points (a basis point is 1/100th of a percentage point).

So what caused these manic-depressive shifts in the market? Initially, the markets were behaving in a typical “risk off” trade, which is typical in times of uncertainty–investors tend to desert stocks and rush toward high quality bonds. But then the markets took another look and decided that Trump’s presidency would be more like Ronald Reagan’s, with buoyant government spending and tighter money. Some think markets were also soothed by Trump’s conciliatory acceptance speech, assuaging concerns about his previously erratic behavior.

Trump has proposed infrastructure spending to jump start the economy, along with constructing the infamous “wall” and other agenda items. With control of both houses of Congress going to the Republicans, the markets decided some of Trump’s proposals may actually happen. The scenario reflected in its sharp swing upward is one of fiscal stimulus with a positive impact on the economy and stock market, rising inflation, and a corresponding increase in bond market yields (depressing bond prices).

There are several problems with this scenario, with one of the biggest being that there is a lack of detail on the proposals. How Congress will act is also unknown. We do not know whether Republicans will rally around a Trump agenda, or hold onto deficit reduction goals which caused so much sparring with a Democratic administration. The Republicans also narrowly outnumber Dems in the house, so it is possible that Democrats may act as a barrier to Trump proposals. There simply is so little we really know at this point.

I think this recent example of mistaken short-term forecasts demonstrates the folly of basing portfolio strategy on that type of outlook. I think it also proves the worth of a diversified portfolio. If you have invested according to strategies designed at Kulig Financial Advisors, you have an appropriate allocation to stocks, and since they are diversified, you have exposure to the groups which have performed well in the recent upswing. Your bond portfolio does not include long term bonds, which were most negatively impacted by the recent tick upward in rates. It also included TIPs (Treasury Inflation Protected bonds), which did relatively well in the Make America Spend scenario recently favored by the markets.

I anticipate another question, which is now that markets are embracing a higher growth, more inflationary scenario, would that merit a change in portfolio strategy? My response is mostly no. We certainly would not recommend buying more stock, unless you are underweight that asset class; you may find you are overweighted after the last upswing in stock prices, and in addition, they have factored in a lot of economic growth in a very short time and are highly valued. Neither would we recommend leaving the bond market; growth outside the US remains low, and there remains slack in the economy, which could mean that we do not experience high inflation. In addition, you will want your bond money to reinvest at higher rates, should they occur. Also, as mentioned earlier, we have not ventured into long-term bonds and generally do not due to their higher interest rate risk.

The sole area where we do not have much portfolio exposure, which we have been reviewing for a while, is in the commodity arena, which could benefit from a Trump inflation scenario. If we do add this asset class to portfolios, it would be a small percentage as a hedge against an inflationary scenario that may not be kind to stocks or bonds. However, we have found the structure of most commodity funds troubling, as they are heavily weighted toward oil, making oil prices the dominant driver of returns to these products. Also, they do not offer income, which clearly does not meet the needs of some clients. We will keep you posted on our thinking as it develops, either in this newsletter, or individually as seems appropriate for your portfolios.

Charitable Giving

Despite the unpredictable world we live in, I am grateful to be in a profession where I may add to the abundance of my clients. In turn, we may share that abundance with others, whatever our level of income or assets. I also know I am grateful for all of my clients. I truly enjoy each and every one of you.

We are also grateful to be building our business year after year, thanks to you. To give back to the community and commemorate all of you, we are donating 10% of Kulig Financial Advisor’s profits to the Foundation for Financial Planning, which is a non-profit devoted solely to pro bono financial planning. For more on this organization, please see http://www.foundation-finplan.org/ and know a part of every dollar you spend here goes to support a worthy cause.

Kulig Financial’s Holiday Schedule

We plan to be closed both the week of Thanksgiving (week of November 21st) and December 19th through January 1st. Then we will be back at it, refreshed and ready to start another year.

A happy Thanksgiving to all!

 

Investment advisor representative of an investment advisory services offered through Garrett Investment Advisors, LLC, a fee-only SEC registered investment advisor. Tel: (910) FEE-ONLY. Kulig Financial Advisors may offer investment advisory services in the state of Massachusetts and other jurisdictions where exempted.