4TH QUARTER 2018
In Need of Market-Maalox?...
The closing quarter of 2018 provided the investment world with another bout of volatility, similar to the opening quarter of the year, and reminded us once again that the capital markets are not a one-directional escalator that only goes up. The media hype surrounding the absolute numbers of the market’s intraday moves, to say nothing of the drama they focused on its whiplash-like multi-directional gyrations, served as a much-needed reality check for the unseasoned hands in the markets as they attempted to run from the volatility, rather than take advantage of it as a normal part of the investment landscape.
After nearly a decade since the market’s March 9th, 2009 nadir, the absence of volatility in the last several years created a sense of unrealistic complacency that was at odds with the globe’s geo-political dynamics. Ten years ago, the great recession exposed a highly leveraged financial system that was interconnected (and overly interdependent on sketchy real estate lending practices) in ways not previously foreseen, and resulted in – to put things in relative perspective – a more than 40% decline in the domestic equity markets.
The economic and market recovery since then, featuring a more than 400% rebound in the DJIA, seems to suggest that a 13%-ish retreat during the last quarter of 2018 should be looked at as more of a normal consolidation of the advance, and not the beginning of the end of mankind as we know it. Granted the absolute point-changes were eye catching, but on a relative percentage basis the advances and declines of last year didn’t even make the top-20 list of biggest daily changes in the indices.
“Wednesday’s (12/26/18) 5% rise for the S&P 500 shocked investors out of their holiday relaxation. But such large movements aren’t as rare as you might think: The index has gained more than 4.5% in a single day on 24 occasions in the past 40 years and dropped at least that much a total of 29 times.
“The majority of those wild swings came in close proximity to one another, during bouts of volatility that lasted weeks or even months. In the six months after Lehman Brothers’ bankruptcy in September 2008, the S&P 500 logged 17 drops of more than 4.5% in a day, along with 10 up moves just as large, including two days of greater than 10% gains. 1987’s Black Monday market crash, when the S&P 500 dropped 20.5% in a single day, was followed up by a 5.3% increase the next day, and a 9.1% gain the day after.”
- N Jasinski, Barron’s 12/28/18
But regardless of the magnitude, the Grinch-like swings of the indices’ daily prices during the last quarter resulted in a couple of predictable reactions that regularly surface during periods of market turbulence. One, which we’ve talked about in this space of late, is the resurgence of more defensive dividend-paying sectors as a haven to ride out the volatility while continuing to collect an income stream in excess of that offered in the money-market fund arena. And the other one, equally anticipated unfortunately, is that normally sane people become emotionally attached to the musings of the media’s talking heads and believe they can pull off the difficult (and most often unsuccessful) investment feat of profitably timing the market during periods of volatility. And as we saw during the 2008-2009 Great Recession, this usually results in folks getting out near market bottoms and “waiting until it’s safe” to get back in, which is usually near market tops – demonstrating the antithesis of the buy low, sell high mantra of prudent long-term investors.
Understandably, the optics of the current round of political dysfunction in our nation’s capital, exacerbated by an outbreak of partisan truth-decay that spreads via a severe case of twitter-plomacy, gives us all pause - but as we’ve previously experienced, this too shall pass. As the eloquently sarcastic Alan Simpson eulogized at President Bush’s funeral:
“Those that travel the high road of humility in Washington are not bothered by heavy traffic.”
Our sincere hope is that we see a change in that reality going forward.
In the interim, we need to keep our focus on the basics of successful long-term asset accumulation – and that time in the markets is more important than the timing of the markets. Equity market returns are not linear, are historically lumpy, as detailed above, and therefore suggest that the best strategy is to remain invested.
According to Morningstar, from 1997 through the end of 2017, the domestic equity markets provided an average annual return of 7.2%. However, should you have missed the best 10 days during that period, your return drops to 3.5%. If you had been out of the markets for the best 30 days during that 10-year span, the return is a negative (0.9%). So if you were to contemplate market timing as a potential investment strategy, it might be instructive to channel one of Clint Eastwood’s Dirty Harry quotes from the 1971 movie:
“…you’ve got to ask yourself one question – Do I feel lucky?...”
Absent possession of the investment world’s 4-leaf clover, we continue to be advocates of a truly balanced portfolio structure, diversified both globally and from an asset class standpoint, that can be refined to meet one’s evolving needs, as well as react to anticipated changes in the capital markets’ landscape. As we’ve talked about before, we’re not fans of blindly remaining fully invested in passive index funds, but instead choose to use relative valuation analysis to identify those opportunities that the momentum herd may have overlooked. Our bedrock has always been that the changes in the price of an asset don’t necessarily change the income that the asset provides: stock dividends are paid as a dollar-amount-per-share, and bond interest is paid per-bond, so a snapshot-in-time-pricing of an asset doesn’t reflect the cash flow a long-term investor will continually receive.
Morningstar also did an analysis of trailing stock market returns for the years 1926 through 2017 to highlight the importance of a longer term focus: one-year annualized returns were positive 74% of the time, while 5-year annualized returns were positive 86% of the time…and 15-year annualized returns, likely the most relevant time frame for prudent long-term investors, was positive 100% of the time. So despite all the shorter term gyrations that the markets naturally go through, staying the course can be the panacea that normalizes returns and smooths out the market’s occasional downdrafts, somewhat akin to Cyndi Lauper’s 1983 ballad (albeit, likely not referencing the stock market):
“If you fall, I will catch you, I’ll be waiting…
Time after time…”
Rather than looking at the pricing on monthly statement as a measurement of investment success, time horizons consistent with one’s life goals would be a more relevant analysis. To wit, a 65-year-old investor with a need for income in retirement, could have more than another 20 years on the planet, so if that person’s portfolio was producing sufficient, and consistent, income, what difference is one quarter’s changes in price if it’s not impacting the cash flow of the invested assets?
Focusing on a balanced, and diversified, income generating portfolio will most likely be the appropriately prudent strategy when facing periods of uncertainty and volatility going forward.
Domestic and Global Market Recap...
The potential dangers gathering in the financial markets became reality as 2018 ended. As we mentioned last quarter, the mess surrounding the UK’s attempt to exit the European Union, trade tensions, difficult corporate earnings comparisons, and rising interest rates all can contribute to slower economic growth and a difficult market environment.
After gaining 9% through the first 3 quarters of 2018, the S&P 500 gave it all back and finished 2018 with the first negative return in 9 years. Volatility increased as earnings estimates were lowered. The technology sector, which had led the market gains, took a severe tumble. Energy stocks reflected the weakness in oil pricing which had its worst quarter since 2004. Trade sensitive stocks were impacted by deepening tensions with China after the arrest of a senior executive of a huge Chinese telecom company.
The economy saw mixed results as the GDP slowed but employment remained strong. Wage growth continued at a 3% clip. Overshadowing the positive reports was the explosive growth of the federal deficit – which is projected to top $1 trillion in 2019, a 25% rise from 2018. Political disputes also began to worry markets as a partial U.S. government shutdown started during the final week of the year, a situation that has potential for catastrophe
Potential for slowing growth helped bond pricing, as US Treasuries remained a safe haven. The broad US bond market returned 1.8% in Q4 and ended with a positive return on the year. US corporate bonds have a preponderance of issues that are just in the investment grade category. Negative business circumstances would have consequences for this sector.
Global stocks did not escape the damage. The EU market declined as growth slowed and Brexit concerns increased. The danger from leaving the EU without an agreement is difficult to overstate. Prime Minister Theresa May had to delay a vote on her proposal after failing to gain support from Parliament – even from her own party. The complexity is enormous, and the British people are now finding that one should always be careful what they wish for. The European government bond market was the only bright spot, much as in the US.
Japan was also caught in the sell-off as equities finished near the lows for the year. Stocks in countries across Asia fell as the same worries of slowing growth and trade wars impacted investors. Emerging markets fell, and the Chinese market had its worst quarter since 2015.
Overall, it is a challenging environment for investing. Nothing lasts forever – bull markets or bear markets, global expansions or contractions, which is why we focus on the long term.
Every stock market correction is different, and the one we just had in the 4th quarter did not disappoint. Between September 28th and Christmas Eve, the S&P 500 fell 19.3%. Ouch!!
While there were plenty of “events” that could be blamed for the drawdown, most of them were predictable. Growth in momentum trading and the impact of thin liquidity around the holiday season were likely factors in the volatility and downward pressure. Several of the previous quarter’s leading sectors were severely impacted this quarter giving credence to this theory. The downside during the 4th quarter was led by Energy, then Technology, Industrials and Consumer Discretionary. The only sector that was positive during the quarter was Utilities.
After its first-quarter collapse and mid-year complacency, the Utility sector came roaring back in the 4th quarter, as the sector is often viewed as a safe haven when fears of global trade wars and economic slowdowns spook the market. Utilities was the only sector in positive territory with a .92% return. The sector ended the year with a 3.91% return compared to the S&P500 of -4.42%. While there is a decent amount of earnings growth potential, capital investment in smart grid, renewables and reliability, potential regulatory shifts and increasing interest rates may put a dampener effect on the Utilities sector in 2019.
While healthcare was down close to 10% during the quarter, it ended the year as the best sector with a 5.87% return. Healthcare is considered a defensive sector, so it makes sense that it went up with Utilities. There are a lot of positives going for the sector besides being a defensive one. Balance sheets are solid, the stocks generally have good dividends, and valuation is good as well. Government legislation could cause some volatility within the sector as regulations and the ACA are debated. The sector however remains flush with cash, increasing the possibility of higher dividend payments, stock buybacks and mergers and acquisitions, like the Bristol-Myers/Celgene deal that just occurred. The biotech part of healthcare should also see decent growth in 2019.
Consumer Discretionary & Technology
These two sectors seemed tied at the hip. They lead the way through 3 quarters, only to give most of it back in the 4th. Technology was down 18% during the quarter and Consumer Discretionary 16%. They both ended the year basically flat, with Consumer Discretionary holding a small gain of .09% and Technology losing 1.29%. The momentum that propelled these two sectors higher seemed to reverse and was possibly made worse by limited liquidity during the holidays. These two sectors are poised for growth and it remains to be seen if the trade negotiations will slow things down. Lower energy prices should help.
In October 2018 the IRS announced cost-of-living adjustments affecting dollar limitations for retirement plans in 2019. Most limits for 2019 will change because the increase in the cost-of-living index 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.
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 a sampling of the organizations that our firm, employees, colleagues and clients are involved with, should you want to consider supporting their missions.
Portland Harbor Hotel’s Ice Bar Benefit – This annual event, running this year from January 24th to 26th, 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
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 1st. Tickets and more information can be found at http://www.cgcmaine.org/auction/
American Heart Association’s Go Red Luncheon – Will be held March 21st at Holiday Inn By the Bay, and will raise funds for the battle against cardiovascular disease and stroke. Additional information can be found at https://ahascarborough.ejoinme.org/MyEvents/20182019MaineGoRedForWomen/tabid/982189/Default.aspx
Also, please feel free to visit our evolving 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 24 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.