MARKET COMMENTARY - Fredric W. Williams

Living In Interesting Times…

Although not intended as a reference to the supposed ancient Chinese curse, it goes without saying that the big-picture view of mid-year 2017 would be more than generous in describing the first six months of this year as being merely “interesting”. From the strains of global economics to the surprising role social media is now staking out in the realm of political “commentary”, a young man’s song lyrics from 1964 seem as appropriate now as they were then:      

“The line it is drawn, The curse is cast
The slow one now, Will later be fast
As the present now, Will later be past
The order is rapidly fading, And the first one will later be last
For the times they are a-changin’…”

- Bob Dylan

Maybe this was the future Nobel Prize winner’s spin on the old Aesop’s fable about the tortoise and the hare, or perhaps he was taking a pass at the then-lagging discipline of value investing during the era of the “Nifty Fifty”…although somehow I tend to doubt the latter.

Regardless, anyone of a certain “maturity” can look back over their lifetimes thus far and recognize the prescience of his commentary, as well as the litany of benchmarks that we’ve passed in the interim. 2017 is the year that Sgt. Pepper’s Lonely Hearts Club Band celebrates its 50th anniversary, while 40 years ago we began our Star Wars journey, and 30 years ago we “celebrated” Wall Street – both the movie and the 1987 market crash. And it’s been 25 years since we were treated to the cinematic excellence of “Wayne’s World” and “Cousin Vinny”, two radically different, albeit perhaps not culturally significant, commentaries on the early ‘90’s.

The passage of time provides the opportunity for perspective as we evaluate “change” to determine its potential permanence, while at the same time attempting to determine the future. We know now, for example, that the dot-com bubble and the sub-prime mortgageinduced real estate crisis were clearly discernable looking back after the fact - apparently indicating that in the heat of the moment many of us get swept up in the momentum of the crowd (aka “irrational exuberance”). Who knows now if “it’s different this time” with the FAANG’s of the world, and that commerce will only take place going forward on the internet? Or if everyone on the planet will walk around staring at piece of technology in their hands and communicating with their fellow humans only through various social media software platforms? Only time will tell.

Similarly, time and technology have transformed the world’s capital markets from the staid 10:00-to-4:00 “Exchange Day”, to the advent of 24-hour global trading (and media commentary), to crowd-sourcing and micro-loans, and to the myriad of packaged investment products being foisted on the public by the “engineers” in the retail financial services industry.

One of these outputs has been the trend towards passive investing whereby mutual funds and exchange-traded funds provide broad exposure to stocks and bonds through the use of index investing, affording investors the ability to “own everything” in one fell-swoop. Rather than structuring a customized portfolio with selective investments chosen based on their relative valuations, passive index investing buys everything within its respective index – the good, the bad and the ugly.

Couple this broad-swath approach to investing with the macro dynamic of a market actually shrinking in the raw number of investment opportunities and we find interesting implications for the future:

“The data are striking. Globally, the number of publicly listed companies has fallen from 10,853 in 1996 to 5,985 last year, a 45% decline, according to data provided by Pantheon [a private equity firm]. In the U.S. the number of stocks has fallen by half in the past 20 years, from 7,322 to 3,671 last year.”
- J. Kimelman; Barron’s 6/28/17

So although the overall value of the global capital markets continues to grow, the number of investing options have decreased dramatically, and these passive index funds have become the proverbial elephant-in-the-room:

“We call it a stock market, but these days it has many more indexes than it does stocks: There are nearly 6,000 indexes, up from fewer than 1,000 a decade ago.” - K. Tan; Barron’s 7/8/17

The structure of how the indices are built can influence the impact they have on the overall market, but the real canary in the mine may be their growing popularity, as some measure the size of these passive index funds as accounting for more than 35% of the capital in the domestic equity markets. These strategies have become an increasingly large part of market’s activity, but are often comprised of investors that are price insensitive: when funds are added to a market cap-weighted fund or ETF, that entity immediately invests the dollars – and those companies having had increased in value the most get a larger portion of the funds allocated to that particular index, suggesting that passive index investors could be blindly “buying high”, regardless of any relative price considerations.

Who among us, when buying a vehicle, would walk into the dealership and just write a check for the MSRP of a car they have an interest in buying? We’d all comparison shop, and negotiate the best deal we could at a price as far as possible below the current sticker price. Passive index investors are apparently content to pay the current “sticker price” and merely be riders in the car, going wherever the index ends up, regardless as to whether it best meets that individual’s needs. We believe that it may be better to be drivers of the car where one can perhaps better determine the most appropriate direction and velocity, among other attributes, of an individual’s portfolios.

We at OPA don’t think that accumulating and managing wealth is best served by merely throwing assets into the capital markets indiscriminately and hoping for the best. We believe that a more effective strategy involves determining an investor’s unique perspective and constraints, and using those as the basis for portfolio allocations that can be a more effective means of meeting an individual’s needs, and of navigating the vagaries of the globe’s many investment opportunities.



Cart Getting Ahead of the Horse?

The second quarter of 2017 was a period of above average investment returns, aided by solid, if unspectacular growth in global economy and the absence of any volatility in financial markets. The Dow, S&P 500 and NASDAQ have all remained within 3% of their highs during 2017. Risk assets continued their rally during the second quarter, as international equity markets outperformed the U.S., emerging markets bested developed markets and high yield bonds bested investment grade.
Investment returns outpaced economic gains in the U.S. as growth was constrained by weakness in auto sales and housing starts as supply outpaces demand. Business spending also remained soft, depressed by elevated inventory numbers and weak capital goods orders. During the quarter, the Dow added 3.3%, the S&P 500 2.6%, and the NASDAQ was up 3.9%. The first half of 2017 produced the highest return for the S&P 500 in four years while the NASDAQ saw its best results since 2009. Gains were driven largely by the 14% gain in technology and 16% return in health care. Energy was the main laggard as oil prices dropped from a supply glut stemming from US production.
The S&P 500 delivered nearly 14% year-over-year earnings growth, the highest growth rate since 2011. A continuing lack of momentum in GDP will eventually impact earnings growth. It is difficult to maintain earnings growth in the mid-teens when GDP growth is in the low single digits.
Emerging markets continued the outperformance seen since late 2016 as their economies had stronger growth than developed markets. Emerging market equities returned 6.4% in the quarter with year-to-date returns of 18.6%. Developed market economies returned 6.4% and 14.2% year-to-date. The Eurozone gained on reduced political risk, decent economic data and improved corporate earnings.
The bond market was aided by the weak economic growth and a lack of inflation. Interest rates remain low despite the Fed’s attempts and 10-year U.S. Treasury rates fell to 2.15%. As the quarter ended, there was growing concern with the path of Fed rate hikes in light of the weaker than expected inflation data. The Barclays aggregate bond index just 1.4% for the quarter but high yield bonds outperformed, returning 3.2% for the quarter.
The Treasury yield curve has been flattening during 2017. The spread between the 10-year note and the 30-year bond started the year at around 125 basis points but has dropped to as low as 80 recently. A flatter curve is typically a sign that the market is expecting lower inflation rates or is concerned with the macroeconomic environment. Inflation had shown signs of life early in 2017, driven by higher energy prices. Supply and demand imbalance in the crude oil market then turned energy prices sharply lower causing year-over-year inflation below 2%.
Cash has returned just 0.2% for the year, as investors on the sidelines have missed out on healthy returns across a wide array of asset classes thus far in 2017. Far better returns were found in cryptocurrencies, a marketplace with significant volatility but one where Bitcoin has gained over 100% in 2017. Old Port Advisors continues to provide diverse risk-managed portfolios that are customized and aligned for our clients and their particular needs and we are still cautiously optimistic about the economy and the markets.


SECTOR OVERVIEW - Richard "Chip: Harlow

The dog days of summer are with us and that tends to bring slow trading days and little volatility. Sector leadership stayed roughly the same with Technology, Healthcare, and Consumer Discretionary leading the way with double digit YTD performance.

Despite the continued political wrangling over Health Care reform, the Healthcare sector outperformed both in the last quarter and the last month (4.62% month-over-month), led by biotechnology stocks. This sector is still trading at a discount to the market, and so there is still perceived value.

Technology has had a pullback in the latest month, down -2.70% m/m, but still leads the sectors on a YTD basis. June saw a pullback in the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) based primarily on perceived value and some profit taking. The pullback in Tech should not be considered a warning sign of bad things to come, but rather a long overdue correction. This Tech correction is simply allowing other segments to catch up a bit, which is what we all should want to see in a healthy bull market.

Consumer Staples
Consumer Staples has seen a pullback in the latest month primarily due to Amazon and its disruptive forces. On June 16th, Amazon announced it will acquire Whole Foods Market for approximately $14B in cash. Strategically, Amazon should see opportunity in bringing its logistics prowess to the grocery chain model and perhaps even solve the home delivery enigma. Shall we ask Alexa to deliver the Thanksgiving turkey and all the fixings??

On July 3rd, the ISM Manufacturing index came in quite strong at 57.8, the first day of 2nd half of 2017, which gave a shot in the arm to many lagging segments. Notably, the New Orders component hit 63.5, and on July 6th the ISM Nonmanufacturing came in strong at 57.4. On the negative side, the International Monetary Fund (IMF) just lowered its forecast for US economic growth to 2.1%, mainly based on lowered expectations regarding President Trump’s ability to introduce fiscal stimulus. But even without it, year-over-year corporate EPS growth has been robust such that prices can increase further without multiple expansion.

While stocks are now generally more expensive than average in a rising rate environment, safe assets are similarly richly valued. There is a sharp reduction in European political risk and there’s been a slowdown in US inflation, thus lowering the risk of a quicker than expected Fed cycle. The global expansion is chugging along and financial market volatility is subdued. As always, Old Port Advisors will look to match the proper risk-managed assets to our clients.


One Year Later, Fiduciary Rule Battle Still Taking Shape…

Ah, the regulation that keeps on giving…

The Trump administration has for now ended its delay of the implementation of the Department of Labor’s “Fiduciary Rule”. The rule became partially effective on June 9th (about seven weeks later than the April 20th date originally mandated by the legislation). The rule, enacted as law by the Obama administration in June of 2016, is on pace to become fullyeffective on January 1, 2018. At that time an investment advisor will have to provide justifiable, fully transparent cost documentation when moving a client’s rollover assets from a retirement plan to their own advisory service; the documentation has to show that the rollover transaction is “in the best interest” of their client. This rule will primarily affect broker-dealers who sell (and are paid by) products, and who have never acted in an official fiduciary capacity. It will require them to conduct their business outside of their current compliance environment. It is an environment that will be less forgiving, and is causing many of them to rethink business models, compensation structure and revenue streams.

The distinction as to which type of advisor you have is important. Opposite of the broker-dealer is the Registered Investment Advisor (RIA). RIA firms like Old Port Advisors are already regulated under a fiduciary standard of care and are minimally impacted by the fiduciary rule since they/we are already working in the client’s best interest. RIA’s typically charge an asset-based fee for service, do not receive compensation from mutual funds, and carefully avoid conflicts of interest.

During the transition period from June 9th to January 1st, all firms are required to act under the Impartial Conduct Standard (ICS) which has three conditions: they must operate under the best interest standard of care (i.e. as a fiduciary would) for their clients; they must charge no more than reasonable compensation (still a wide range), and they must not make any materially misleading statements (which a fiduciary shouldn’t anyway). There is no documentation requirement until January 1st, 2018.

It is still possible that this rule is going away. Several officials in the Trump administration have made it clear that they think it is bad for business and too restrictive. The 60-day waiting period the DOL implemented in April 2017 was to allow “further study” of the rule and gave administration officials time to marshal some opposition. There are several indications that the rule will not be in force in the way it was originally written, if at all, come January. The DOL has issued a Request for Information (RFI) for more input regarding the impact of the rule. The comment period ends at the end of July. Stay tuned. No matter what you hear about the Fiduciary Rule and its impact, Old Port Advisors supports it (we’ve always had to operate as a fiduciary), and it is good for the consumer.


FRED WILLIAMS – His home was featured in the May issue of Old Port Magazine, as well as making the cover photo, in a piece that detailed the collaborative design process he went through to build his Munjoy Hill residence. The story can be found online at: www.oldport.com/around-town/homes/hillside-story/

It’s with great sadness that we note the passing of Missy Lyon. A colleague for more than 20 years, both during her tenure at Charles Schwab and then when we were fortunate enough to have her join Old Port Advisors, Missy’s presence in her family, community, and in our firm, will be greatly missed. - FWW


Old Port Advisors was founded more than 20 years ago 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. Our principles were simple and still ground us today: a values-driven, personalized, collaborative, and strategic approach to investing, wealth management, and fiduciary consulting. We changed our name to embark on the next 20 years, but our leadership and our calling remain. We’re excited to build on our past experience and success to deliver on our promise of building a secure future for our clients.