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Market Commentary 09/30/2018

What matters today                                                                                         

The third quarter faced numerous challenges, but the S&P 500 still posted a solid 7.4% return for the quarter and is up 10.56% year to date.  This momentum in the U.S. market is due to a few investor favorites.  The FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) contributed to more than half of the S&P 500 index gain this year.  International and emerging markets continue to struggle due to tariffs, a strong dollar, and geopolitical disruptions. The bond market continues to reset with gradually rising interest rates.

The numbers in most sectors, due to earnings, are still showing strong signs of continued growth.  Recently however, Liz Ann Sonders, Schwab senior vice president and chief investment strategist, said a weak housing market can be a drag on growth.  “Housing is what we call a leading indicator:  It can signal future turning points in the economy before they actually show up. And even with all the good news out there for unemployment, wages and the stock market, the recent data from the housing market is sending some negative signals. It’s not all bad, of course, but it’s still worth watching.”[1]

Clearly no one really knows when the market will turn negative.  In fact, an August 2018 Betterment survey found that 48% of 2,000 American adults thought the US stock market had been flat over the last 10 years.  Another 18% of those surveyed thought the US stock market had declined over the last 10 years.[2]   We are in an almost ten-year bull market which has had its volatility throughout the run up.  As we all know, stock markets don’t go straight up.  This extended bull market has experienced seven corrections of 10% or more over the past 9½ years, including one in 2011 of 19.4%.  There have also been four smaller pullbacks in the 6%-8% range.[3]   This added volatility may be one of the reasons those surveyed by Betterment felt the market was flat.

We have had many discussions with our clients over the course of the year about preparing for the next downturn.  They are now expressing their concerns about the potential for declining markets in the future.  No one knows when that may happen, but our investment philosophy has always been about building a portfolio that lessens the decline.  Although most economists and market strategists don’t see a recession until 2020 at the earliest, we believe portfolio construction should be our focus.

Why portfolio construction matters

Portfolio construction is not just simply owning different sectors for the sake of diversification.  We instead help identify the risks associated with each asset class relative to your needs.   For example, as the economy slows in a rising interest rate environment, you want to own higher quality stocks that can sustain a slowdown, and higher quality low duration bonds to ride the rate cycle up to protect principle investment.   Don’t ignore recently underperforming sectors that have positive outlooks such as developed international and emerging markets.

We have been slowly restructuring our client portfolios over the last few years by taking profits, increasing exposure to small company stocks, and adding to developed international and emerging markets to position portfolios for the next leg up when the U.S. markets slow.  Sometimes we are early in the cycle and therefore are buying low.  Keeping a long-term view can benefit your success.  As Warren Buffet states in his October 16, 2008, New York Times article, “be fearful when others are greedy and be greedy when others are fearful.”[4]

The FAANG stocks have contributed in large part to this momentum market recovery that began in March of 2009.  Investors have been greedy as these stocks have advanced despite being costly to buy.  Momentum markets can excite investors to think that there is no end in sight.  When they decline the lack of diversification eventually appears.  The fear factor shows up when the momentum disappears, and investors sell based not on price but on loss.

Although the investing landscape has changed over the past decade with investors gravitating to more indexes, their emotions still drive their investment decisions.  It’s difficult to be patient when it looks so easy to just pick an index.  We certainly are not saying don’t own these in your portfolio, just don’t overweight in a momentum market.  Investors don’t realize the inherent risk that is within the broadly followed index.  When a single index falls during a sell off, what is your offset investment that balances the volatility?

A well-constructed portfolio will allow you to own those investments that provide income when you need it, opportunities for the future, and provide peace of mind to get through the toughest of markets.  We think prudent portfolio construction will smooth out investors’ outcomes over time.  Our philosophy is to construct a portfolio that will withstand short-term emotions by allocating enough to bonds and fixed/cash investments to weather the downturns.  This enables you to maintain your lifestyle regardless of volatility.

It is almost impossible to predict the next downturn, although we know it will happen.  Keep your expectations in line with your portfolio.  Portfolio construction is somewhat like maintaining a home.  There are always ongoing repairs that go into maintaining it.  If you keep up the property you slowly build value.  The same is true of our portfolios; if we keep them up to date by managing risk you will have opportunities for smoother and better outcomes.

Thank you for believing in the philosophy that has helped our clients weather all market conditions.  We welcome your questions and concerns and look forward to our continued discussions.

 

Thomas L. Menzel, CFP®                     Laura A. Biermann, CFP®
President/Principal Owner                  Vice-President/Principal Owner

[1] Liz Ann Sonders, Schwab Newsroom Insights, 10/03/2018
[2] AMG Funds, 09/24/2018, By the Numbers; Betterment survey
[3]  Wall Street Journal, 09/09/2018 “Reflections on the 91/2 Year-Long Bull Market
[4] Warren Buffett, New York Times 10/16/2008, “Buy American, I Am”


IMPORTANT DISCLOSURES: The opinions presented in this communication are subject to change without notice and no representation is made concerning actual future performance of the markets or economy. Information obtained from sources is considered reliable but is not verified. The research and other information provided herein speak only as of it date. We have not undertaken, and will not undertake any duty to update the research or information or otherwise advise you of changes in the research or information. Performance information presented is not an indication of future results and index data is provided for market reference purposes only. This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. This document is the property of Legacy Financial Advisors and is intended solely for the use of the Legacy client, individual, or entity to which is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person without the express consent of Legacy. This material is for educational purposes only. Mis-transmission is not intended to waive confidentiality or privilege.