The Markets	03/31/17 Close	12/31/16 Close	1st Qtr. Change	03/31/16 Close	12 Mo. Change	YTD Change
Dow	20,663	19,763	+4.55%	17,685	+16.84%	+4.55%
NASDAQ	5,912	5,383	+9.83%	4,870	+21.40%	+9.83%
S&P 500	2,363	2,239	+5.54%	2,060	+14.71%	+5.54%
MSCI EAFE	1,793	1,684	+6.47%	1,652	+8.54%	+6.47%
10-yr Treas. yield	2.40%	2.45%	-0.05%	1.83%	+0.57%	-0.05%
Fed funds rate	0.75% to 1.0%	0.50% to 0.75%	+0.25%	0.25% to 0.5%	+0.50%	+0.25%

(stock indices are before dividends; yield and rate changes are absolute changes)

The “Trump trade” that propelled markets after the election on the hope for loser financial and environmental regulations continued for much of the quarter with the US stock market rising into March. The market then treaded water and may now be looking for earnings and actual policy implementation rather than trading on expectations. The price of oil also softened in March but managed to close above $50, giving energy companies some breathing room. Still, it was a very positive quarter and the trailing 12 month performance is strong across the board. The 0.25% interest rate increase in March was again no surprise to anyone and the bond market took it in stride.

The Fed’s rate increase was based on improved business investment, inflation creeping closer to the 2% long-run target and a balanced outlook for growth in the near term. Core consumer prices did reach a five-year high increase of 2.2% from the prior year. Further rate increases would be “gradual” depending on the outlook although there is some indication from the Fed that they would rather raise rates early to avoid a steep increase if inflation picks up.

The bigger news from the minutes of the Fed’s March meeting was the plan to begin winding down the assets held on the Fed’s $4.5 trillion balance sheet later in 2017. There were no details but it appears the Fed will be reducing its holdings of both Treasuries and mortgage bonds. It had previously been assumed that the Fed would first simply not reinvest as bonds matured, rather than outright selling bonds, but now it appears they could shake up the bond market. There was a nine-month period during which foreign investors overall had been selling Treasuries, with private investors selling more than central banks were buying.

New jobs kept their strong pace, growing another 235,000 in February, beating expectations. Unemployment came in at 4.7% but wages finally began to creep up, growing 2.8% year-over-year (YOY). The employment-to-population rate hit an eight-year high of 60% and the employment rate for ages 25 to 54 was at a six-year high. There were over 5.6 million jobs available, leading over 3.2 million people to quit their jobs (the most in 16 years) with confidence they could find another job. This job and wage growth boosted consumer confidence to a 16-year high and the outlook from a CEO survey jumped the most in seven years.

Housing remains strong but is constrained by tight supply. Homebuilder confidence reached a 12-year high (which could be interpreted as overconfidence), new home sales were up over 12% YOY and existing home sales hit a 10-year high in January. Median prices were up 5.7% for new homes and 7.7% for existing homes. Still, total spending on housing is at 15.6% of GDP, well below the 60-year average of 19%. Spending on new homes and remodeling were similarly below their historical average. Overall, the homeownership rate was 63.7%, below both the high of 69.2% in the housing boom and the 65% rate that is considered “normal”.

The final GDP growth estimate for the fourth quarter was up to m2.1%, just a bit better than the expected 2%. The rise was driven by personal consumption, up 3.5% for the quarter, and improved fixed investment by companies. On the other hand, reduced federal government spending and stubbornly high imports were a drag on GDP. For the full year 2016, GDP grew 1.6%, still below the 2% level which is seen as a minimum long-term goal.

Looking Forward

Last quarter offered the obvious observation that the scope and speed of changes from Washington could significantly impact the economy and markets. As Dr. Phil might say, how’s that working out for ya?

So far the biggest impact of the new administration has been promise and ideological rumbling rather than legislation. The overhaul/repeal/replace/whatever of health care died on the vine. There has been no concrete proposal on tax legislation and most regulations are still in place. There has been some loosening of environmental rules and the Keystone pipeline was given an approval. Overall, given the improvement in the economy and the higher level of confidence, gridlock and little actual legislation could be the best things that could happen for the economy and the markets.

Of course, the long-term issue of the national debt is a big concern. Prior to any tax or budget reform, the Congressional Budget Office projects the debt to double to 150% of GDP by 2047; the debt is now 77% and has already doubled just since 2008. There will no doubt be disagreement about the impact of any tax and budget proposals but it could be interesting if there is any analysis that shows at least some slowing in the growth of the debt.

The UK officially started the two-year Brexit clock and will face a delicate balancing act. With Scotland making noise about independence to remain closer to the EU, it will be critical to preserve the “united” in the United Kingdom. Britain will try to maintain close economic ties with the EU and some protocol for foreign workers while also addressing fears that it has been too easy for foreigners to come to Britain; whether that immigration has added to terrorism threats or diluted British culture is as unclear as in other countries. At the same time, politicians will want the UK to create its own global trade policies and cut regulations and taxes not that it is free from the EU.

Our Portfolios

I have had the pleasure of speaking recently to several groups of younger people on personal finance and investing in particular – an undergraduate class of the U of A, a meeting of young professionals in Tucson and part of a year-long course on personal finance for millennials. It was encouraging to see that there is growing recognition of the fundamentals of successful investing.

My conclusion usually includes a summary of those fundamentals – expenses matter, time is your friend in both generating returns and weathering volatility, know your objective and invest accordingly, don’t get seduced by sales pitches. Those are all sound and quantifiable rules but they are missing an emotional connection.

It is important that the investment strategy be consistent with your temperament and what you personally want to get out of the experience, aside from positive returns or income. That may mean peace of mind, or the perceived excitement of picking individual stocks, or the satisfaction of using investments as a platform for education, or just feeding your competitive nature. These expectations are sometimes the result of misguided advice, cultural norms or simply a lack of knowledge. A disconnect between the actual investment approach and your temperament will certainly lead to even more inconsistency and changes which lead to dissatisfaction and worse performance – a vicious cycle.

This alignment does not have to “all or none”. You may have greater risk in your career or in other financial ventures such as real estate or direct business ownership, making a more conservative investment approach a good balance.

It should come as no surprise that our portfolios are designed to support peace of mind and ongoing education. We have had fairly consistent success in helping clients adjust their perspective and their expectations and they come around to the idea that a less expensive and less risky portfolio is actually a good thing despite the lack of excitement. It does not always work that way, and we still have clients who slice off a small piece of their portfolio to pursue their own investment ideas. We are fine with that, and no one would be happier than us if a client hit a home run with that piece of the portfolio. It hasn’t happened yet.

In the meantime, we continue to monitor our portfolios and test whether the approach still makes sense. These efforts seldom result in big changes to our portfolios but they keep us and our clients on track.

401 IS Okay

The fee levels of investments in 401(k) retirement plans have come under pretty intense scrutiny, and we commented back in August, 2015 (401 Not So Okay). More recently the architects of the original idea that led to the introduction of the first 401(k) have publicly expressed some disappointment on how those plans have evolved.

In the 25 years since the first 401(k) plan, many companies have eliminated their traditional pension plan in favor of a 401(k)-only retirement benefit. This has led, in the opinion of many, to the serious lack of retirement savings by most Americans. Companies have been able to offload their prior pension obligations onto the backs of workers who are either unprepared or unwilling to choose to participate in the plan. Employees don’t contribute enough, make poor investment decisions and often disrupt their retirement savings by taking loans from their retirement accounts.

The basic disappointment is that the 401(k) was never meant to be the sole retirement vehicle, but rather a supplement to other retirement programs. To support that argument, only 19% of private employees now have a traditional pension plan as compared to 36% of private workers in 1980.

But look more closely at that change. First, this data on pension coverage references only private employees. Most government employees still have pension plans and the benefit formulas for many of those plans were sweetened in the late 1990’s. (Never mind that public pension plans are greatly underfunded and the taxpayer will eventually be on the hook for the bill. We wrote about that problem as well in The State of Pensions.)

Second, while it is lamentable that fewer workers have pensions, if 36% of private employees had pensions in 1980 that means that 64% of private workers did not have the benefit of a traditional pension, even in 1980. Those 64% had to fend for themselves with neither a pension nor a 401(k) and even the IRA was only introduced in 1974 (with an annual contribution limit of a whopping $1,500). So what has changed that has made it so much more difficult for workers to financially prepare for retirement?

One big change has been in job tenure. The average job tenure of all workers age 25 or older barely changed from 1983 to 2016, at just over 5 years. But for older workers (age 55 and older) the change was more dramatic, from 13.5 years in 1983 to only 10.2 years in 2016. And that job tenure will likely continue to decline, with current data suggesting the average worker today will have from 10 to 15 jobs in his or her working career. In addition to throwing off steady savings plans, these job changes may come with interruptions to income, relocation, further education and other changes that add to expenses. (Shorter job tenure would also impact pension benefits since those benefits are based partly on years of service.)

Life expectancy has increased (until leveling off recently) and medical costs have gone up dramatically. Education costs for children have also gone up much faster than the rate of inflation with many parents shouldering student loan debt well past retirement age.

Without hard data to support the theory, cultural changes have probably contributed to the retirement challenge. Smaller families and the scattering of families mean less close family support for retirees. Even if relocation is not involved, Americans are more likely to change houses than in the past and to spend discretionary income on travel, cars, entertainment and other luxuries rather than saving for retirement. Even worse, many people go into debt for short-term pleasures at the expense of their long-term security.

There is no denying that Americans are woefully unprepared for retirement. But most workers have always been responsible for their own retirement and if a worker diligently contributes to a 401(k) and is financially responsible otherwise, odds are a comfortable retirement will be waiting.