MARKET COMMENTARY - Fredric W. Williams

Year of the Spinners…

Not to be confused with the great R&B vocal group from Detroit that brought us, interestingly enough, the smooth soul of what would become the “Philly Sound” (It’s a Shame; Then Came You, amongst a long and memorable list), but 2017 may very well be remembered as the year that “spin” morphed from merely being a verb into a prevalent form of communication.  From social media’s potential outside influencers, to the apparent head count discrepancies at the inauguration, and to the lack of reporting transparency on the part of certain corporate entities, one could almost surmise that self-serving obfuscation became the rule, rather than the exception, last year.

And although we expect these shenanigans in politics, even the cynics amongst us had to admit that 2017 elevated the concept of “alternate facts” to a new and unforeseen level. What was a bit more concerning, though, was the disclosure that the brave new world of social media may have unwittingly been used as a distribution platform for truly “fake news”, and that companies in the new technology space (like Amazon and the absence of specific numbers relative to its device sales and Prime memberships) were able to provide a version of an opaque outline that harkened back to the dot.com’s “pro forma reporting” of nearly 20 years ago.

“From Washington to Wall Street, there’s simply less concern about being called out on the facts…That’s a problem not just for journalists, but for investors as well. When information is imprecise, investors often get burned. The risk is greatest at high flying tech stocks where hype already tends to overwhelm reality…The risk is that we’re operating on so little information, and at such high valuations, that if things go wrong, they’ll go very wrong.”

  • Alex Eule, Barron’s, 12/29/17

Despite these concerns, it appeared that enthusiasm trumped rational valuation analysis as the markets marched ever higher last year. To be sure, the continued expansion in corporate profits, along with the prospects for tax reform, and a global economy demonstrating synchronized growth in a low inflation environment, was the perfect Goldilocks combination in 2017 – with the only question being whether all these factors were already priced into the capital markets by early in the new year.

But for one of the forces behind this upward move in the markets, none of this really mattered. The continued flow of funds into passive index strategies hasn’t concerned itself with this data, and perhaps contributed to a self-fulfilling prophesy as indiscriminate buying of these funds continued the purchases of the largest companies that had gone up the most – almost like momentum trading.  Having not seen a meaningful decline or correction since the lows of early 2009, it’s conceivable one of the factors for this index-investing affinity is built on the belief that elevators only go in the upward direction and that algorithms have become traders for all seasons…both of which may be a tad disconcerting.

Another issue is the unseen sector concentration that has resulted from this migration of funds into index strategies. The portion of the S&P 500 that was invested in technology has averaged 19.6% for the last 10 years, and by the end of 2017 had jumped to 23.8% - an increase of 3% in just one year, since the end of 2016. And the same dynamic can be seen in the MSCI Emerging Markets index, where Asia’s surging tech stocks drove that sector’s concentration up almost 5 points to 28% of the index in one year…which, of course, means that the most expensive, and most volatile, sector has become the largest sector (by more than 50%) within these indices.

Additionally, in light of the fact that the bulk of retail investors’ assets have flowed into bond funds since the financial crisis, the recent creep up in inflation will need to be watched as it could have a bifurcated impact on the markets, given the corresponding increase we’ve been seeing in interest rates.

The initial moves up in rates could kick off an exodus from bond funds, when there’s the realization that these funds could actually go down in value. With few other options offering an acceptable current yield, these assets could then be directed toward the equity market, stretching valuations even further in what many are predicting could be a “melt up” driven solely by demand. Eventually these rising interest rates could come back to haunt the equity markets as the future cash flow discounting calculations will get reset:

“If we see an uptick in inflation and interest rates, it could be negative for long-duration technology stocks—software-as-a-service companies, and other like Netflix and Tesla, where investors expect a pot of gold at the end of the rainbow. Tesla will be cash-flow positive in 15 years? If interest rates go up, the discounting mechanism is going to take a chair saw to the valuations of a lot of these companies.”

  • Paul Wick, Columbia Threadneedle Investments

“Paul makes a good point. If rates go up, long-duration assets will be negatively affected. It is evident in the tech world and the bond market, but it is also true in equities. Companies like Netflix and Tesla don’t have earnings to speak of. They are essentially options. When rates go up in option models, the present value of expectations goes through the floor.”

  • William Priest, Epoch Investment Partners

Given all this, it might cause investors to reflect on some past guidance, albeit provided to a far different field of “finance”:

                              “You’ve got to know when to hold ‘em
                                Know when to fold ‘em
                                Know when to walk away
                                And know when to run…”
  • Kenny Rogers, The Gambler, 1978

To be certain, we are not advocates of “getting out”, given the lack of reasonably yielding alternatives, as well as the low percentage of success associated with the timing of wholesale migration of assets in and out of the capital markets. But we’re long-enough in the tooth to remember the last time we heard the phrase “This time it’s different” (during the late ‘90’s), and think that reflecting on valuations and reallocating assets based on those data points still makes a great deal of sense for prudent long-term investors.

Accordingly, we stand by our previous comments in this space as we venture into the new year:

“We are neither Pollyanna’s nor Cassandra’s, but believe that relative and absolute valuation analysis provides the objective parameters that can help cut through the emotional tunnel-vision of the herd.  We, for example, find a number of less “stretched” sectors, particularly overseas, although domestically as well, that can provide ample opportunities to secure lower P/E and higher dividend-yield allocations for capital. Our goal has never been to attempt to “time” the market, but instead focus on investment themes that increase the likelihood of finding an empty chair when the music inevitably stops.”  


Domestic and Global Market Recap                                                       

The fourth quarter of 2017 saw large gains across the board in global investment markets, capping off a remarkable year. The IMF increased its global growth forecast for the year to 3.6% amid signs of a sustained, synchronized recovery from the 2007 collapse. Equities were the star, with the US market boosted by corporate tax cuts. Despite the beginning of central bank tightening, bond markets also had a decent year. The Eurozone faced political head winds and ended the year with a negative quarter. Brexit negotiations dominated the UK landscape, while Japan and emerging markets posted gains.

The unwavering advance of the US stock markets was measured by the string of record closes and a lack of any setbacks. It has now been over 22 months since the markets have had a 5% reversal. The S&P 500 added to a stretch of unceasing gains, up 6.6% for Q4 and 19.4% for 2017. The strongest sector was technology, which rose 40%, which drove helping the NASDAQ to a sixth straight positive year with a gain of 28.2%. It was a broad-based market advance with nearly all sectors averaging high double-digit returns. The laggards were utilities, REITs and other yield stocks.

Tax reform was the big story as the year came to a close, with large, permanent tax cuts for corporations. In addition, robust corporate earnings, especially from technology, added to hope for an uptick in the recovery. After a large setback, like the credit meltdown of 2008, the economy historically recovers at a 4% rate, vs. the 2% the US has seen since the bottom of the crisis. The Federal Reserve raised its estimate for GDP growth in 2018 to 2.5% from 2.1% based on third quarter of 3% and stronger November employment numbers. The missing piece remains wage growth.

European equities did not fare as well as MSCI EMU was slightly negative in Q4. A strong euro offset continuing economic growth, with GDP up 0.6%. The unemployment rate improved to 8.8%, the lowest it has been since the early days of the crisis in January 2009. Political events held back the markets; in Germany coalition talks fell apart after Merkel’s reelection and Spain has the threat of Catalan separatists adding uncertainty. The UK markets rose 5%, cheering Brexit proponents, at least for one quarter. The Bank of England raised interest rates for the first time since November 2007.

Stocks in Japan were up 8.7% in Q4 after a snap election in October. Earnings remained strong as did virtually all economic figures. Unemployment dropped to 2.7%, emphasizing the demographic constraints Japan faces. China remained strong with a reported Q3 GDP growth of 6.8% after the governing party consolidated its power at the congress held in October. India and Korea saw strong advances as did emerging markets.

The bond markets face the end of central bank intervention that has kept interest rates artificially low since 2007. The US Treasury bond yield curve continuing to flatten and rates trended higher. Corporate paper did better with positive total returns and investment grade outperforming high yield. The commodity markets generally were positive, particularly industrial metals and crude, further signs of an ongoing cyclical recovery.  

Sector Overview - Richard “Chip” Harlow

No matter how cold it got in here in Maine, nothing could cool down the markets.  Despite some sideways December trading, the tech sector was still the runaway champion.  In addition, five other sectors beat the broad market index, and only two, energy and telecom, posted minus signs for the year.  Here are some quarterly sector highlights.

The 2017 Champ:  Technology

Technology was the best-performing sector globally this year, racking up an impressive 38.8% gain for the year. This performance was supported by better-than-expected earnings and revenues that beat estimates.  The FAANG (Facebook, Amazon, Apple, Netflix, & Google (Alphabet)) still led the way. Technology is likely to remain at or near the top for two important reasons. First, Tech is the only sector in the S&P 500 that gets more than 50% of its revenue from overseas, so it will benefit from the expected synchronized global growth.  Second, all other sectors rely on new technologies to improve service and productivity, so Tech rides along with (and often drives) growth in them.  For 2018, the most discussed growth trends are in robotics and automation – with changes coming more quickly than most people expect.

The 2017 Runners Up:  Consumer Discretionary, Financials, Healthcare, Industrials, and Materials

All of these sectors finished the year in the 21-23% range, with Consumer Discretionary taking the lead in December, due in part to holiday shopping.  Economic growth in the US actually accelerated toward year-end, notwithstanding the already extended business cycle. With inflation tending to surprise to the downside, monetary policy generally remained clearly accommodative. The Fed was the only central bank to raise interest rates more than once, while most other advanced economy central banks remained on hold and various emerging markets were able to cut interest rates quite considerably in response to lower inflation. In combination with accelerating economic and earnings growth, easy money provided a powerful backdrop for strong gains in equities and other risk assets.

The U.S. stock market got a shot in the arm when Congress passed tax reform legislation.   Notably, passage of tax reform immediately changed the nature of money flows into sector ETFs, with Technology being passed over – at least temporarily – in favor of Financials, Energy, Materials, and Industrials, as these are the sectors widely expected to benefit the most from lower effective tax rates, deregulation, and infrastructure spending.  Most sectors should benefit from the legislation, notably the Energy sector and its effective pre-reform tax rate of 37% likely to see a meaningful benefit.

Another benefit of the legislation:  a one-time repatriation clause that allows companies to repatriate overseas cash without penalty.  The S&P 500 has $920 Billion in cash overseas; $252B of which is Apple’s. US companies are expected to use these repatriated funds to primarily pay down debt, buy-back shares, conduct M & A activity, and spend on capital expenditures.


2018 Regulatory Limits for Retirement Plans


In October 2017 the IRS announced cost-of-living adjustments affecting dollar limitations for retirement plans in 2018.  Most limits for 2018 will change because the increase in the cost-of-living index (2%) hit the statutory thresholds that would trigger Cost-Of-Living-Adjustments (COLA).  These adjustments, if any, are typically in $500 increments for contribution limits and $5,000 increments for compensation limits.  Below is a chart of some of the more important plan limitations.

Important Limits





402(g) Deferral Limit

(401k, 403b, & most 457 plan elective deferrals)




The maximum amount a participant can annually contribute through salary deferral.



Catch-up Contribution




The maximum amount a participant 50 and older can additionally contribute through salary deferral each year.


Annual Compensation Limit




The maximum amount of compensation allowed for contribution calculation purposes.



Highly Compensated Employee




The compensation threshold at which an employee becomes defined as highly compensated.  Important salary deferral and contribution allocation testing.

Limit on Annual Additions: 

Defined Contribution Plan




The maximum annual amount allowed to be contributed for an employee from all contribution sources (employee, employer).


Social Security Wage Base




The maximum earnings level allowed to be taxed under the OASDI program.  Important for calculations integrated with social security.


Key Employee Officer Comp




The compensation threshold at which an employee can be considered a potential “key” employee.  Important for “top-heavy” calculations.


Grandparent-Owned 529 Plan Withdrawal Strategies 

College funding is a popular concern with many of our clients.  Recently (2015) there was a change in the way the Free Application for Federal Student Aid (FAFSA) looks at grandparents owning 529 Plans - withdrawing the 529 Plan monies in the wrong order may hurt someone’s financial aid package.

529 Plan Overview

A 529 Plan is a state sponsored plan where monies are deposited, grow tax – deferred and qualified distributions are income-tax free.   A 529 Plan will have an account owner and account beneficiary.  Depending on who owns the account can affect how the monies are counted for financial aid purposes.  Each state offers various plans and benefits (tax deduction matching grants, etc.).  Account owners can change the beneficiary if needed.

529 Plan: Parent-Owned

When a 529 plan is owned by the parent it is considered a parental asset for financial aid purposes.   This means that 5.64% of the asset total is counted towards the Expected Family Contribution (EFC).  It is not considered as income for the student.

529 Plan: Student-Owned

If the 529 plan is owned by the student and the student is a dependent for tax purposes, it is counted as a parental asset.  If the student is the owner and is independent/not a dependent for tax purposes, 20% of the account balance is counted towards the EFC.

529 Plan: Grandparent-Owned

When grandparents fund a 529 plan for grandchildren it is not counted as an asset on FAFSA.  This is a wonderful way for grandparents to help with education and not lose control of the assets.  They can even change the beneficiary of the plan or take the money back (with penalty and taxes).

The Grandparent-Owned Accounting Change

Prior to the rule change, when a student used grandparent-owned 529 plan money, it counted as income to the student for the following year (this was problematic - student income is assessed at a rate of 50% for FAFSA above a $6,260 earning allowance - large withdrawals from a grandparent owned 529 plan increased the parent’s EFC as the income was assessed at the much higher 50% rate). In this scenario, the most effective use of grandparent-owned 529 plan assets was in the student’s senior year of college as it would have no effect on financial aid.  

The new rules add a “gap” year.  Previously, freshman withdrawals from grandparent-owned 529 plans would be treated as income for the sophomore year FAFSA and would likely hurt financial aid awards.  FAFSA now looks at income from two years prior.  In our example, the 2017/2018 college year is now referencing 2015 income data, and not 2016.  Now, students can use the grandparent-owned 529 assets junior and senior years without any impact to their financial aid calculations in the FAFSA.  Note:  if applying to a private college using the CSS profile, you may be asked to include grandparent 529 plan assets.


Fred Williams – Joined the Board of Trustees for Bay Chamber Concerts and Music School ( http://www.baychamberconcerts.org/ ) in 2016, and was elected Treasurer this last fall. Based in Rockport, Maine, and founded more than 55 years ago, their mission is to enrich the lives of people in the Maine community through high-quality concert programs, music education and community engagement. With a two-pronged approach to promoting excellence in the performing arts—through education and live music programming—Bay Chamber Concerts and Music School connects a wide range of audiences and ages to some of the most vibrant music and musicians in the world.

Sharon Bunker – Having recently been promoted to a Portfolio Manager Associate, Sharon has continued her professional development by completing the course work for her designations as a Registered ParaplannerSM or RP® and a Chartered Retirement Plans SpecialistSM or CRPS®OPA is pleased with the additional skill sets Sharon will use to provide our clients with their planning and projection needs going forward.

OPA Out & About:

The start of a new year is when a variety of non-profit organizations further 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.

Upcoming Events

Portland Harbor Hotel’s Ice Bar Benefit – This annual event, running this year from January 25th to 27th, features ice carvings and an outdoor venue, and provides funds for area non-profits. Additional information, and tickets, can be found at http://www.portlandharborhotel.com/portland-harbor-hotel-ice-bar.php

Waynflete School’s Wintertide Community Auction – This year’s dinner, entertainment and auction will be held February 3rd at Brick South on Thompson’s Point and will benefit the school’s financial aid endowment. Information and tickets can be found at https://waynflete.ejoinme.org/MyEvents/Wintertide/tabid/911871/Default.aspx

Center for Grieving Children’s Love Really Counts – Their annual benefit auction and dinner gala will be at Brick South on Thompson’s Point, Friday February 9th. Tickets and more information can be found at http://www.cgcmaine.org/auction/

American Heart Association’s Go Red Luncheon – Will be held March 13th at Holiday Inn By the Bay, and will raise funds for the battle against cardiovascular disease and stroke. Additional information can be found at http://www.heart.org/HEARTORG/Affiliate/Maine-Go-Red-For-Women-Luncheon_UCM_431886_Event.jsp#.WlJVO2inGUk

Community Support

Again this year we chose to make additional contributions to area cultural and community organizations that our OPA Team works with. Below is a partial list of those entities, which we intend to expand in the future, along with their respective contact information:

Big Brothers Big Sisters (http://somebigs.org/) ; Bay Chamber Concerts (http://www.baychamberconcerts.org/ ) ; Mitchell Institute (http://mitchellinstitute.org/) ; Restorative Justice Institute (http://www.rjimaine.org/) ; United Way Small Business Circle (http://uwgp.org/365 ) ; Lift360 (http://www.lift360.org/) ; Kennebec Land Trust (http://www.tklt.org/) ; Dream Factory of Maine (https://www.facebook.com/dreamfactoryportland/) ; Center for Maine Contemporary Art (http://cmcanow.org/) ; Preble Street (http://www.preblestreet.org/); Animal Refuge League (http://www.arlgp.org/) ; Community Television Network (http://www.ctn5.org/) ; The Locker Project (http://mainelockerproject.org/) ; The Jackson Laboratory (https://www.jax.org/) ; Frenchman Bay Conservancy (http://frenchmanbay.org/) ; Equality Maine (http://equalitymaine.org/) ; Ronald McDonald House Charities (http://rmhcmaine.org/) ; Gulf of Maine Research Institute (http://gmri.org/); Holocaust & Human Rights Center of Maine (http://hhrcmaine.org/); Maine Sports Hall of Fame (https://www.mshof.com/)  

Also, please feel free to visit our new website (www.oldportadvisors.com) as we continue our rebranding efforts and build out more of our online capabilities.

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.