|10-yr Treas. yield||2.74%||2.40%||+0.34%||2.40%||+0.34%||+0.34%|
|Fed funds rate||1.5% – 1.75%||1.25% -1.5%||+0.25%||0.75% – 1.0%||+0.75%||+0.25%|
(stock indices are before dividends; yield and rate changes are absolute changes)
We almost forgot about volatility but it returned this quarter, if not with a vengeance, certainly enough to get our attention. There were four waves that contributed to the volatility tide – the quick increase from January 1, the hint of inflation, the uncertainty over protectionism and trade wars and finally some miscues by technology companies. The broad market just barely hit its first “correction” (a drop of 10% from a recent high) since January, 2016, recovered and then swooned again. The overall quarterly change is digestible but masks all the swings along the way; still, the negative quarter broke a string of nine positive quarters, the longest streak in 20 years. The US dollar hits its lowest level in 2 ½ years but international stocks still drooped. Interest rates participated in the gyrations, shooting up 0.54% to 2.94% before also drifting lower by the end of the quarter. The yield on two-year Treasury notes exceeded the dividend yield on the S&P 500 for the first time since mid-2008, which could cause income investors to shift from stocks to safer bonds.
And all this happened over the nine-year anniversary of the bull market which began on March 9, 2009 and the ten-year anniversary of the bailout of Bear Stearns.
The first wave – inflation – was triggered by a strong January jobs report that included wage growth of 2.9% from a year prior, the best growth since 2009. The market eventually remembered that wages have been stubbornly resistant to increases during this growth period and subsequent wage reports, as well as all other inflation measures, were more benign. Next came trade concerns, or more accurately trade confusion, as President Trump announced tariffs on imported steel and aluminum. Again, the market took a deep breath and seemed to decide it’s better to wait and see what really happens.
Three technology darlings hit bumps, causing the third wave. An Uber autonomous vehicle hit and killed a pedestrian in Tempe, leading to the suspension of autonomous vehicle tests and calling into question whether self-driving cars can live up to their hype. Similarly, a Tesla driver was killed using the Autopilot system while Tesla is still far behind production targets for its lower-priced Model 3. Finally, the basic idea of social media came under scrutiny as Facebook allowed user data to make its way to a political research firm, raising questions of potential regulations on the use of data and, for users, whether social media is worth exposing so much personal data.
The new Fed chairman, Jerome Powell, took office and clearly signaled that the Fed would continue down the path laid out by prior chairman Janet Yellen, who was not asked to return despite generally being considered to have done a good job. The Fed raised rates as expected in March with two more increases expected in 2018. The outlook for 2019 and 2020 was steepened, with near-term risks to the economy “balanced” and inflation stable near the 2% target.
The final growth in GDP for the fourth quarter was 2.9% on strong consumer spending and an employment rate holding steady at 4.1%. Consumer confidence, incomes, manufacturing and services activity were all trending in the right direction. Total household debt continued its five-year rise to a new record high of $13.15 trillion and reached 67% of GDP compared to 87% in 2009. Still, overall delinquencies over 90 days fell to 3.12% and total net worth grew to almost $97 trillion, also a record. Home sales were strong but supply, especially of affordable new homes, is very thin.
“Trade wars are good and they’re easy to win.”
With that proclamation President Trump captured both the excited anticipation of those who feel free trade has hurt the US and the concern of those who feel trade barriers will harm our economy (and may also feel that President Trump does not fully understand trade or global economics).
Trade tariffs have a long history (tariffs were the greatest source of federal revenue until the income tax began in 1913) and have evolved from playing a principal role in foreign policy to a more industry-specific tool. The General Agreement on Tariffs and Trade (GATT) was established by the US in 1947 to liberalize trade among capitalist countries and minimize tariffs and other restrictions. GATT evolved into the World Trade Organization (WTO) in 1995 and open trade became dominant worldwide. The WTO created a forum for countries to argue against unfair or subsidized trade and unilateral tariffs became less common.
The most recent example of unilateral US tariffs was in 2002 when President Bush placed temporary tariffs of 8% to 30% on imported steel following a surge in steel imports and the bankruptcy of over 30 US steel makers. The tariffs were intended to last three years and were met with criticism for either not being tough enough or for interfering with free trade. The European Union threatened retaliation and the WTO ruled against the tariffs and imposed $2 billion in sanctions. The Bush administration initially held fast but soon lifted the tariffs in the face of even more international retaliation, some of which was intended to hurt Bush’s support in key states.
Even though the tariffs were in place for only nine months, most studies concluded that the costs of the measures in terms of overall economic activity and employment outweighed the benefits. There was also a “redistributive effect”, with the tariffs creating winners and losers. Redistribution is why tariffs are criticized for being politically motivated, with the winners being political supporters and the losers being opponents.
Trade developments are now happening almost daily. China first announced tariffs on $3 billion on US goods, mostly agricultural, and then expanded the list to tariffs on $50 billion of more agricultural products, some cars, some planes and other goods. This may be posturing by the Chinese since the tariffs have not yet gone into effect but the voices of the perceived winners and losers of proposed tariffs are equally loud.
Whether these first trade volleys turn into an all-out trade war and, if so, what the overall effects will be on the economy, the currency and the financial markets could be very interesting.
The market volatility has increased the number of calls and emails from investment firms touting “alternative” investments that are supposed to either offer protection from market declines or perform in ways that are “uncorrelated” to, or not in synch with, the stock market. We politely decline the discussion because in our experience these strategies seldom perform as advertised, have higher costs and unintended consequences and don’t benefit portfolios over the longer ups and downs of the market. (I sometimes wonder what the person pushing the investment must be thinking about us; either they are frustrated because we are stupid and just don’t get it or they have to concede that we are smart and see through the pitch.)
Our long-term horizon can be tested during times of high volatility. We don’t apologize or make excuses if our balanced portfolios don’t enjoy the performance of the best-performing market nor do we gloat or take any pleasure when those same balanced portfolios avoid the painful drops of the worst-performing. The goals remain the same – to support our clients’ needs and enjoyment of life and to provide education, context and perspective so that short-term events are less stressful.
We encourage clients to get in touch if they have questions or concerns about the markets and of course we heard from some clients during this quarter. I am very pleased to report that many more of our clients wondered whether this is a buying opportunity than expressed fear of potential losses. The underlying advice to stay the course is the same for both.
If It Walks Like a Duck
Every business tends to get immersed in its own terminology and issues and to the outside observer those issues can seem abstract or trivial. Financial services is no exception and most people just want to be treated fairly and honestly without concern for the internal intricacies of the business.
A current debate involves who should be able to call themselves a “financial advisor”. Investment professionals used to be called “brokers” but as clients came to expect more than just investment advice the terminology evolved and today nobody calls themselves a broker. The problem is that with everyone using the “financial advisor” label it is even harder for the public to know how the individual is compensated.
Or perhaps that’s the real reason for the shift to “financial advisor”. With more attention being paid to investing costs, using a title that confirms that the individual gets paid for sales is not necessarily good for business.
This has led to a debate over the proper use of titles. On one side are investment professionals who are “registered investment advisors”, have a duty to act in the best interests of clients and get paid based on assets or some flat fee. They would like to see stricter guidelines to prevent anyone who gets paid from selling an investment or other product from using “financial advisor”. On the other side are traditional brokerage firms who claim that not being able to use “financial advisor” would unfairly taint them in the public’s eyes; even if they do get paid from sales they also provide other financial advice and the cost of using a registered investment advisor could be as much or more than using a “broker”.
(We offered our satirical April 1 plans to introduce a new firm called Clown Car Advisors because “most people who hold themselves out to the public as financial advisors are really just clowns dressed up as captive salespeople”.)
Here’s a common sense, compromise solution that unfortunately has little chance of being adopted. If there is any compensation from selling an investment or product, the person must always first identify themselves as “sales” (investment sales, insurance sales, etc.) After that they can call themselves whatever they want (financial advisor, wealth manager, genius) but not in a more prominent way than the sales title. Those who are required to use the sales title may not like it but they are always free to change their business model.
Like most services, financial services is hard to evaluate because clients can’t see it or touch it and have to wait until the service is provided to evaluate whether it was appropriate. But unlike other services, investment advice is notoriously difficult to evaluate even after the fact. Maybe a little truth in labeling would help the public and maybe the industry should just get over it.