1ST QUARTER 2019
Bungee Bounce-Back Bull…
Thought to be in need of life-support during the 4th quarter 2018’s decline, the domestic equity market’s version of the raging bull (not the 1980 film adapted from Jake LaMotta’s memoir, starring Robert De Niro), none-the-less, stumbled into the new year, turned 10 years old and proceeded to claw back almost all of the last quarter’s decline during the first three months of 2019. The headwinds that precipitated Q4’s 19.1% drop (a near-bear experience, as Terry points out below) continued to exist in the first quarter of 2019, except for the Fed’s January pivot-move, which now suggests rates may not continue upward absent an assessment of their impact on the domestic and global economies.
The persistence of the equity market’s advance over the last decade, along with the rubber-band like rebound from this most recent sell-off, makes one think that investors are blithely singing along to Jackson Browne’s 1978 cover of the Four Season’s Maurice Williams hit “Stay” (cue your best falsetto):
“Oh won't you stay,
Just a little bit longer,
Oh please please please stay,
Just a little bit more”
Although “hoping and wishing” isn’t usually considered a sound investment strategy, it appeared that is was in abundant use as market participants considered the potential friction from rising rates, trade tensions as an impediment to global growth, and the long-term impact of overly xenophobic approaches to diplomacy and globalism. As technology continues to make the world smaller, we become even more interconnected in an increasingly interdependent economy, so denying that reality smacks of tilting at windmills in a somewhat Don Quixote-esque fashion.
Over the short run these uncertainties are creating disparities in global markets, as capital trends to perceived safety, and in sector valuations, as FOMO (fear of missing out) continues to push lemming-like investors to momentum stocks, based on near-term past performance biases. The spreads between the developed and developing markets, as well as the growth versus value sectors, are at extreme levels, so those prudent investors patient enough to wait for the reversion to the mean, could be well rewarded.
“The valuation spread between the market’s cheapest stocks and the most expensive ones has risen to the widest level in the past 70 years…valuation spreads are at record-setting levels not only across the market, but also within many individual sectors.”
“At the same time, although the value spreads between the most expensive and the cheapest stocks have been widening, the gap between the two groups’ growth rates hasn’t expanded much. This means that value stocks cheaper prices are not justified by worsening fundamentals, leaving hope for them to rise when the time is right.”
- Evie Liu, Barron’s, 3/28/19
Firmly ensconced in the value sector are dividend paying stocks, a core component of our long-term OPA investment discipline centered on compounding cash flows. Much like the late ‘90s when these companies were considered “old fashioned” compared to the various tech stocks that ran to the top of the dotcom bubble in 2001, we’ve seen a similar bifurcation dynamic since the bottom of the market back in 2009’s Great Recession. The NASDAQ hit its peak in 2000, dropped more that 50% by the end of 2003, and didn’t recover to a new high until 2016…which reminds us of Mark Twain’s observation that history may not repeat itself, but often times it rhymes.
We’re not suggesting any impending apocalypse in the markets, but the return of volatility last year is reinforcing our focus on the “quaint” attributes of these equity-income shares:
“Dividend stocks may not be as sexy as their faster-growing counterparts, which typically offer more price appreciation in rising markets, but they do provide investors with a steady stream of income along with the potential for capital gains. What’s more, dividend stocks tend to be less volatile than their nonpaying peers, and the companies that can afford to pay dividends often have strong balance sheets.”
“While most investors buy dividend stocks for the steady income stream, that isn’t the only benefit these investments offer, financial experts say. Indeed, research shows that dividend stocks often outperform their non-dividend-paying counterparts over longer periods.”
“From 1958 through 2018, a portfolio with the top 20% of S&P 500 companies ranked by dividend yield and weighted by market capitalization outperformed the overall S&P 500 by 2.13 percentage points annually…”
- Dan Weil, WSJ, 3/3/19
We continue to believe that navigating the all the potential economic uncertainties, caused by our current spat of political gyrations, will be best served by maintaining prudent portfolio exposure to investment opportunities with these predictable cash flows.
Domestic and Global Market Recap...
As 2018 ended, three months ago, the financial markets were declining on disappointing economic data and low inflation in several key regions. The US was in the middle of the longest government shutdown in its history and its trade policy was creating tension with important trading partners. The UK was in the equally humiliating position of having no idea how to cleanly exit the European Union despite years of promises. US stocks were also facing difficult earnings comparisons.
Three months later, with the possibility of trade progress with China and a lower Fed funds rate, global equities had their strongest quarter since 2010. Fixed income also rallied sharply. Amid the signs of an economic cooldown, the U.S. Federal Reserve pivoted from its interest rate-hiking plans to possible rate cuts. Fourth quarter US GDP was revised down to 2.2%, with full-year growth at 2.9%. Other central banks, including in Europe and China, also moved toward easing monetary policy.
This is very much a double-edged sword: a healthy economy does not need very low rates to thrive. For context, remember that the reason Fed funds rates are at this low level is as a result of the recession caused by the mortgage disaster of 2008. To stimulate growth, the Fed had to drop the funds rate to 0.25% in December 2008, where it stayed for 7 years. With the economy recovering, the Fed began the attempt to return rates to typical levels in December 2015, a process that is now halted.
U.S. equities had their highest first-quarter return since 1998 as the S&P 500 rose 14%. Growth stocks outperformed value with technology the strongest sector. The tech-heavy Nasdaq Composite soared 17%. Economically sensitive sectors, including energy and industrials, advanced sharply as investors reset expectations for interest rates and the global trade environment. All sectors rose, but financials and health care stocks lagged the overall market. Bank shares retreated with the prospect of lower interest rates.
Investment-grade bonds also advanced after the central banks signaled that interest rates will not rise for the balance of the year. The 10-year U.S. Treasury yield hit a 15-month low in late March at 2.34%; a yield lower than the 3-month bill. This “inverted” spread last happened in 2007 as the mortgage crisis was taking shape, so it was widely reported as a signal of possible recessionary conditions. The inversion lasted only 5 days and was 6 basis points at its greatest. While it was not much of a signal, Fed Fund futures still are pricing in the probability for a rate cut by December.
Eurozone stocks also rose despite signs of slowing growth and the added chaos of the third defeat of the Brexit plan. England wants both sovereignty and the benefits of a single market, which they cannot have. The British negotiating approach resembles someone with a gun to their own head demanding concessions. European government bonds rose on the ECB’s move to leave rates ultra-low for the rest of the year. Germany’s benchmark 10-year note ended the quarter with a negative yield. Stocks in Japan rose despite lower exports and weak manufacturing orders.
Emerging market and Chinese stocks were boosted by hopes for U.S.-China trade resolution. Like the US, the consumer discretionary, information technology and energy sectors were the front-runners. The MSCI China A Onshore Index climbed 34%.
Commodities had their best quarter in three years. After dropping 38% in Q4 2018, U.S. crude oil rebounded 32% in the first quarter, closing at over $60 a barrel. U.S. sanctions against Iran and Venezuela, along with OPEC-led cuts, boosted prices as supply levels contracted.
A market rally always feels nice – but the higher valuation levels resets risk/return calculations and narrows room for error. The jury is still out on the US corporate tax cut. It has yet to produce stronger domestic growth outside of share buybacks while adding to the deficit. Corporate earnings estimates have been cut every week; in January the aggregate estimate for S&P 500 earnings growth was 2.9%, the expectation is now for a decline of 3.9%. The stock market ended the quarter higher than where many predicted it would end 2019. The booming IPO market can signal overexuberance. For now, the only sign of inflation was wages rising in February at their fastest rate in nearly 10 years. Stay aware and never confuse brains with a bull market.
DOL Target Date Guidance, 5 Years Later
Target date funds hold and invest over $1 trillion in assets, and according to JP Morgan, they account for 85%+ of all new contributions to 401(k) plans. With these funds comes a fiduciary responsibility that requires a little more attention than the typical advisor provides. A little over six years ago, the DOL issued a publication called “Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries”. The document listed eight “tips” for plan sponsors to use in evaluating the proper TDF for their retirement plans. As a general rule of thumb if the DOL is issuing publications with tips for ERISA fiduciaries, plan sponsors should take notice of the topic and incorporate the “suggestions” into their fiduciary review.
Below is a table summarizing the tips and our suggested solutions for compliance below:
If you have any questions regarding TDF selection for your plan, please contact the Independent Investment Fiduciaries at Old Port Advisors.
Grandparent Owned 529 Plans
As most people are scrambling to get their taxes done, many parents with college age children were scrambling to get their Free Application for Student Aid (FAFSA) filed as well. Those parents may be also scrambling to find the funds to pay for college. Some of the more fortunate students have had their grandparents start a Section 529 plan for their college funding. While this is a great benefit, it can impact potential financial aid for the student. Although we have covered this topic in the past, we thought it would be a good time to revisit.
Though grandparent-owned 529 Plan assets are not reported on the FAFSA, the withdrawals do count as income for the student. If a grandparent decides to pay for the first year of college tuition for a grandchild, the withdrawal used to be reported as income for the student the following year (it is now two years later – more on that in a bit). Because up to 50% of a student’s income is considered available to pay for college, money used from a grandparent’s 529 could have reduced aid the following year by as much as half of the distribution amount.
Time the Withdrawals
To minimize the impact on financial aid, families should use grandparent’s 529 money last. One strategy was for the student to take the distribution in their senior year because it wouldn’t count against them on the next FAFSA (there wouldn’t be one since they would have graduated). The new reporting rule allows for a two-year “reporting-blind” period instead of one year, so the student can take a distribution from their grandparent-funded 529 going in to junior year without the income penalizing them on the senior year FAFSA.
Transfer Ownership as an Option
Many states including Maine allow grandparents to transfer the ownership of the 529 plan to the student’s parents. This can be beneficial for students that need the money for all years of college. Be careful though: when the 529 plan becomes a parental asset, it can reduce needs-based aid eligibility by 5.64%. Instead of transferring the entire 529 plan at one time to the parent, it is more beneficial to transfer to the parent on a yearly basis only what is needed. That way only the transferred amount is subject to the 5.64%, not the entire 529. Check the math but this is often much better than grandparent-owned 529 plans paying the first two years and the distributions being counted as student income which is assessed at 50%.
Grandparent owned 529 plans are still be a great option and the 529 plan can be a good estate planning tool allowing grandparents to remain in control of the assets instead of making an outright gift. Grandparents should also revisit the successor owner designation on their 529 plans. Some states have different rules on who takes over ownership in the event of the grandparent’s death. If the student is the beneficiary, it could really change their financial aid picture in a negative way.
Save The Dates:
We’re entering the time of year when a variety of non-profit organizations begin their annual fundraising efforts so they can continue to enhance the fabric of our community. Although by no means complete, the events below are but a sampling of the organizations that our firm, employees, colleagues and clients are involved with, should you want to consider supporting their missions.
Wayfinder School’s Annual Author’s Event – On Thursday April 11th at Hannaford Hall on USM’s Portland Campus, New York Times best-selling novelist, Armor Towles, joins Pulitzer Prize-winning author, Richard Russo, for a lively conversation about books, writing, and “all things literary.” The Author’s Reception is at 6:00 and the Conversation begins at 7:00 – additional information can be found at http://wayfinderschools.org/
Bids for Kids - Benefitting Big Brothers Big Sisters of Southern Maine, will be held on Friday, April 26th at the Holiday Inn by the Bay with light dinner fare, and complimentary Shipyard beer. In addition, the positive effects of mentoring will be celebrated by recognizing the 2018 Matches of The Year. Details can be found at www.SoMeBigs.org
Walk MS – The annual spring walk to benefit the MS society will take place on April 27th at South Portland High School starting at 9:00 AM. Participation provides help for today and hope for tomorrow through education, support, advocacy, and research funded by the National Multiple Sclerosis Society through its Greater New England Chapter. Details can be found at www.walkmam.nationalmssociety.org.
Maine Coast Memorial Hospital’s 26th Annual Chef’s Gala – On Saturday, April 27th, this year’s theme of Spring Block Party will include dining, dancing and fellowship to support their Foundation’s Breast Clinic and its outreach program to provide mammograms for those who cannot afford to pay. Additional information can be found at https://www.northernlighthealth.org/Locations/Foundation/Events-and-Programs/2019/April/2019-Maine-Coast-Chefs-Gala
St. Lawrence Arts – On Thursday May 23rd from 5:00 to 8:00 Munjoy Hill’s neighborhood arts center will hold its annual fundraiser with Allagash Brewery. The event will feature music by Big Ass Rooster, food from Rosemont Bakery and craft beer from Allagash – additional information can be found at http://www.stlawrencearts.org/index.html
25th Annual Child’s Play Golf Benefit – The Dream Factory of Maine is celebrating its 32nd anniversary of granting dreams to the children of Maine and is holding its Child’s Play tournament Monday June 10th at Val Halla Golf Course starting at 8:00 in the morning. The Dream Factory grants dreams for critically and chronically ill children nationwide, is based in Louisville, and has 2 chapters in Maine. Additional information can be found at www.dreamfactoryincmep.org.
Maine Sports Hall of Fame Annual Induction Ceremony – On Sunday, May 19th at 2:00 at Merrill Auditorium in Portland the MSHOF will celebrate its 43rd anniversary and welcome an inductee class that will include, amongst others, world record holder in open water swimming Pat Gallant-Charette, well-known Maine banker and champion tennis player Sam Ladd, the NHL’s top rated official Wes McCauley, and the longtime coach who became the face of Seeds of Peace Timothy (Tim) P. Wilson. Tickets and additional information can be found at https://www.mshof.com/
Fur Ball – On Friday night June 14th The Animal Refuge League of Greater Portland is throwing its annual benefit party at the remodeled Aura in downtown Portland (121 Center Street). A night of food, drinks, and music – all to benefit their life-saving programs. Tickets and additional info can be found at http://www.arlgp.org/ .
25th Annual Fore The Kids Golf Classic – Big Brothers Big Sisters of Southern Maine’s annual fundraiser will be held June 17th at The Woodlands Club. Additional information on this popular two-ball/best-ball event can be found at www.SoMeBigs.org.
Center for Maine Contemporary Art “Art Party” – On Friday June 28th at their Rockland gallery, CMCA will be hosting its annual gala, and after party, to support its exhibitions and educational programming. More information can be found at http://cmcanow.org/
25th Anniversary of the Founding of the Firm
Old Port Advisors was founded 25 years ago this fall as Investment Management & Consulting Group (IMCG), with a vision to create a boutique independent investment management firm centered on the best interests of our clients.
Look for our save-the-date and celebration event later this year!
We’re planning a client appreciation reception for later this year so we can provide a view of the next 25 years and thank the clients and colleagues who have been the reason for our success. We look forward to seeing you there!