SEE THE FOREST THROUGH THE TREES
Are you a long-term investor?
GLOBAL MARKET ACTION
Does it even matter?
Proceed with Caution
Sentiment near 10 year lows
SUMMARY OF INVESTMENT THEMES
SEE THE FOREST THROUGH THE TREES
All investors say they are in it for the long-term. We all may have different goals and risk tolerances but we invest our money for the long-term. With that in mind, short-term volatility can be alarming and emotionally tough to deal with (the trees). But, in order to reap the long-term returns (seeing the forest) that the financial markets offer, one must be able to emotionally grapple with the short-term fluctuations that occur. Try your best to "See the Forest Through the Trees".
If you are not prepared to emotionally endure the negative fluctuations that occur it is best to stay on the sidelines. That is why as a financial advisor I do my best to educate my clients, keep them informed, and try not to chase fads or short-term performance.
I firmly believe that the best investment strategy is not one with the best historical returns, or the best risk-adjusted returns, or the one with the lowest cost. The best investment strategy is one that you believe in and will stick to when the going gets tough.
Even the best-laid strategies have tough periods. That being said, let's take a look at what has actually been happening in the financial markets this fall.
GLOBAL MARKET ACTION
We are currently experiencing the first correction since 2016. What goes up also can come down.
"It's not watch you buy but what you pay for it that determines whether something is a good investment or a bad investment. There is no asset that is so good that it can't become overpriced, and thus a bad investment." - Howard Marks
In October, the U.S. stock market had its largest monthly decline since 2011. The NASDAQ Index lost 9% (it's worst monthly loss since October 2008), the S&P 500 lost 7.3% and the Dow Jones Industrial Average lost 6.4%. After a slight bounce in early November, those indexes have been trending lower again.
Interest rates have steadily been on the rise all year. Because of that, most bond indices are sporting negative returns on the year. According to Morningstar, through November 19th, the Morningstar US Corporate Bond Index is down 3.54%, Morningstar Long-Term Corporate index is down 7.19%. Treasury bonds are down roughly 1.44% and Long-Term Treasuries are down 5.26%. The Barclays US Aggregate Bond Index, which is a wide collection of bonds from different categories and maturities is down 1.89% on the year.
Foreign stock markets haven't been better in 2018. The Hang Seng Chinese index is down 13.56%. The MSCI EAFE (Europe, Asia and Far East) is down 9.27%. MSCI Emerging Markets are down 14.69%. One of the only global markets higher on the year is the Bombay SENSEX India Index at + 4.16%.
Inflation hedges such as the Morningstar Long-Only Global Commodity Index is slightly higher at 1.42% on the year, the Morningstar U.S. Real Estate Index is up 2.37%, but Gold is down 6.87% on the year.
According to University of Florida professor Jay Ritter, more than 80% of U.S. listed IPOs over the past year were from companies without profits. That is the highest amount on record according to data spanning the last 40 years....meaning its even higher than the dot com bubble of the early 2000s.
2018 has been a year where there hasn't been anywhere to hide. Most asset markets are lower on the year and losses have accelerated over the past month or so. The best asset class on the year is short-term bonds that have benefited from the rising rates by paying out higher interest payments and hedged equity.
IMPEACHMENT? DOES IT MATTER?
There seemed to be a lot of anxiety related to the mid-term elections in early November. No matter your political leaning, the media did their best to make it appear as if this was the most important mid-term election in U.S. history.
Very little was surprising in the outcomes around the country and they were pretty similar in totality to most other mid-term elections after the first two years of a new president's term. Republicans no longer control the house and the senate, gridlock could ensue unless bipartisanship emerges.
What seems to be talked about quite a bit now is the possibility of impeachment proceedings and investigations into the President's past financial dealings. I don't have an opinion one way or the other whether it should be done, but the possibility is quite high.
If however, a stock market decline occurs in 2019, I am willing to bet this is the reason pundits will cling to. For the record, I have no idea whether a decline will materialize, and anyone else who thinks they know is just entertaining you.
But, hypothetically, if it does, the narrative in the media will probably sound something like this...
The stock market generally likes stability within our government. However, an impeachment proceeding is very uncertain. Will it occur? Who would take over if it did occur? What would it mean for current policies if it were to occur? Because of this instability, the stock market would act negatively.
That sounds like a reasonable and plausible explanation. However, there is a problem with this "logic". Did you know that during the Bill Clinton impeachment proceedings, the stock market rallied 10%?
How on earth, if impeachment proceedings bring instability...and instability brings stock market weakness, did the stock market rally?
Could it be, that there are a host of other factors that matter much more? Think deeper before believing the prevailing narative.
First, the good news.... Nothing about this correction is abnormal....so far. The depth and the speed may feel different, but that is because of the abnormal low volatility over the past 24 months. Typically, stability breeds complacency, which leads to excessive risk-taking which brings about instability to correct the complacency. Typically, markets experience at least one 10% correction each year, so far, this is all that is. If you have a sound investment strategy that is thought out I would continue to stick to your long-term plan.
Now for the caution... The bounce in the market that occurred in the first half of November has all the looks of a "dead cat bounce". Similar to dropping a ball off a ledge, the ball typically bounces to roughly half the amount of the drop. That is almost exactly what we have seen. Take a look at the following chart and you can see what I am talking about.
The drop into the low on Halloween bounced to recover just over 50% of the decline. We are now heading lower in a "retest" of that Halloween low. I think there is a growing likelihood that at least in the U.S. this correction still needs to run its course. I believe this could be a multi-month to even multi-year A-B-C correction. A being the first move lower, B being a bounce higher and C being a final move lower.
Rather than being a hero, accumulating cash in short-term savings or short-term cash management until this downtrend runs its course may be a suitable strategy. Create a shopping list of investments that you would like to own.
Here is a chart via sentimenTrader that I think does a great job of showing the set up in the precious metals markets. In essence, the sentiment toward precious metals and the need to have them as part of a portfolio is near the lowest levels of the past two decades.....however prices are substantially higher than at other sentiment lows. That is extremely bullish for the precious metals in my opinion.
This chart shows the price of gold over the past decade. The blue line is the level of optimism in the gold market at various times. You can clearly see from the chart that optimism is close to the lowest levels of the past 10 years yet gold is higher in price than at those other levels of pessimism. In the past, those pessimism levels preceeded major advances in the price of gold.
- Rather than trying to “beat the market”, focus on beating inflation and the rate on cash. Plan for safety and liquidity while seeking positive returns.
- Equity valuations are very rich but masked due to the distortion of the Treasury curve. Volatility is returning to the markets and I think long/short managers are best positioned to capture this volatility by owning companies with strong businesses, barriers to entry, and good valuations and selling short weaker companies with high debt loads that have risen sharply with the broad market rally. I think this strategy of hedged equity may have the potential to produce attractive risk-adjusted returns if and when investors begin to question the valuations of companies. Stock investing involves risk including loss of principal. No strategy ensures success or protects against a loss. Long positions may decline as short positions rise, thereby accelerating potential losses to the investor.
- Monsoon country investments. Attempting to take advantage of demographic, educational and investment possibilities in the countries surrounding the old spice routes of the Indian Ocean. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
- A potential U.S. infrastructure upgrade cycle may be around the corner. Moving from our current grade of D+ to B would require an investment of $3.6 trillion by 2020.
- Supply problems remain high across the energy asset class. While there isn’t a current shortage of energy on the planet, it is taking more and more energy and capital to discover, drill, transport and refine it. Long term Demand should continue to grow globally, particularly in China, India, and other developing countries.
- Potential food shortages due to inclement weather and higher demand from the emerging Asian middle class could result in a boon to agricultural land and potash fertilizer companies. International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
- The rise of E-Commerce has coincided with an increased desire for efficient warehouse distribution real estate. As e-commerce moves toward even faster delivery, positioning of distribution becomes even more important.
- Precious metals mining companies have been extremely beaten down over the past four years. Mining is an industry that spans hundreds of years. Companies that mine for commodities are often highly cyclical, meaning they have sustained moves both up and down. When investing in the mining space it is important to be a contrarian. Ideally, you would want to accumulate miners when sentiment is poor around them and sell them when sentiment is positive. Historically this has been a good strategy.
No strategy ensures success or protects against a loss.
Colin B. Exelby
Celestial Wealth Management
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- The fast pricing swings in commodities and currencies may result in significant volatility in an investor's holdings.
- There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
- Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.
- The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
- The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
- The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
- The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.
- The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa.Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.
- The Hang Seng Index or HSI is a market capitalization-weighted index of the largest companies that trade on the Hong Kong Exchange. A subsidiary of the Hang Seng Bank maintains the Hang Seng Index and has done so since 1969.
- The S&P BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also called the BSE 30 or simply the SENSEX, is a free-float market-weighted stock market index of 30 well-established and financially sound companies listed on Bombay Stock Exchange.
- The Morningstar Corporate Bond Index includes US corporate bonds with maturities of more than one year and at least $500 million outstanding.
- The Morningstar Long-Term Corporate Bond Index includes US corporate bonds with maturities of seven years or longer.
- The Morningstar Long-Only Commodity Index is a fully collateralized commodity futures index that is long all eligible commodities.
- The Morningstar US Real Asset Index consists of various indexes that track four different asset classes that have historically displayed high sensitivity to inflation: TIPS, commodity futures-based strategies, real estate investment trusts, and inflation-sensitive equities.
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