Letter to Investors: July 2018
Our mid-year recap and outlook for the remainder of 2018.
Dear colleagues, clients and friends,
July is here. We’ve officially completed half of the year and head into the final 6 months of 2018. It is always amazing how much can change in 6 months, and how much, inevitably stays the same. I hope that you all had the opportunity to enjoy the 4th of July with family and friends to celebrate this great country that we live in. The 6 months of 2018 that have led us here have been active with headline fears of inflation, trade wars and Federal Reserve rate hikes, to name a few. In times of volatility, it is important to have a grasp of the underlying economy and interpret outlook and uncertainty in light of portfolio allocations, objectives and goals. As you read through this letter, you may have questions related to your specific scenario and may find it is a good time for us to review your portfolio and wealth management plan.
Headline News – Understanding Trade Tensions… If you’ve happened to turn on any news, you’ve most likely seen and heard the term, “Trade Wars.” While the trade tensions have not escalated to the status of what experts would call a full-on trade war, it certainly is a concern and impacts the way markets price securities.
If you’ve taken even an introductory course to economics, you’re sure to understand the principal of free trade. For those of you who may not have studied economics (or don’t wish to remember), the principal is that free trade increases economic output. As an individual (or city, or nation, etc.) begins to specialize in a certain area of production, they can trade with other individuals who specialize in separate areas. The effect, is lowering the cost of production through lowering the cost of inputs such as material, manufacturing and labor. Think of an automobile assembly line. Then scale it to international trade. Then add in a very important cost – government.
As the headlines will read, this core, economic principal is at risk as tariffs are levied. With each escalation in rhetoric from world leaders, markets reverse course, selling off shares in anticipation of the economic losses to come. While we feel this risk is real and should not be overlooked – it may be a bit short-sited.
It is important to understand that international trade has never actually been “free” – regardless of the name implied in an agreement. Free trade is by definition, international trade left to its natural course without tariffs, quotas or other restrictions. The agreements put in place by global governments will have some impact in trade, whether through direct quotas and tariffs, or perhaps more subtle, domestic policies towards international companies. Analysts on the subject agree that there is room for improvement in the existing trade agreements. The question, and thus the uncertainty, is whether Donald Trump’s aggressive negotiation tactics will cause more harm than good in the global political theatre.
Though we see trade tensions as a headwind to equity performance, we suspect that underlying global growth may provide greater opportunity. As those economic indicators change, it could very well change our outlook on global equities.
Volatility, Volatility and more Volatility…. As we anticipated and wrote about in our January Newsletter, 2018 has been rife with volatility. This year, the S&P 500 has realized more daily movements of 1% or more than it realized in all of 2017. It had surpassed the number of 2017 market movements in February. By the beginning of April, the S&P 500 had already experienced 28 such days. The uncertainty and thus, the volatility has not quieted since the initial market pull back at the end of January.
So, why so much volatility?
Volatility is a result of market uncertainty. As markets try to forecast and price risk, this creates conditions in which buying and selling occur. This is a normal and important market mechanic. Certain factors that affect markets have a small range of possible outcomes. An example would be tax reform, which is priced into earnings expectations and is well understood from an analyst and forecasting perspective. Other variables, such as trade tensions, have far reaching and widely unknown outcomes. Thus, increased uncertainty. As global leaders spat about trade agreements, the impact of threats, tariffs and diminishing relationships is widely unknown, leading to a greater range of possible outcomes. When those headlines shift – so too does the market outlook.
While a powerful negotiation tool, tariffs and quotas will generate more uncertainty in markets. We agree that trade tensions and tariff increases negatively impact the global economy, and we want to maintain a long-term perspective. We are of the opinion that while this will create significant volatility in the short-term, there is no economic benefit for countries to maintain these tariffs in the long-term, and thus, we would expect new agreements to be created that may encourage more global trade. The tactics for reaching these new agreements are questionable, however the objective is clear – renegotiate existing trade agreements to improve economic output. In a different economic environment, this may be enough uncertainty to encourage a move to safe haven asset classes. In the current environment, we believe this headwind is being balanced by the economic data produced globally.
Outlook, Expectations and Opportunities: The economic output of the global economy is still positive and on a growth trajectory and is our biggest influence in maintaining a positive outlook on equities. And while growth is good, too much or too little can cause harm. Increased inflation concerns, an overly aggressive Fed, or a significant spike in crude oil prices, are factors that may influence our current allocations. For now, we continue to maintain that we are in a late-stage bull market.
We believe that the dispersion in equity markets and the increased use of online trading and ETF products will create opportunities for active management, potentially securing discounted stock positions as markets react to new headlines. Some of these opportunities may be found in financially stable, high dividend paying companies, as well as mid and small cap US Equities.
We will continue to monitor fixed income markets, as a flattening and potential inversion of the yield curve may signal the early stages of a bear market. In the interim, we maintain that fixed income will provide portfolio stability, though interest rates and interest rate hikes are having a dampening effect on income yields. High yield bonds and dividend paying stocks may help to increase income, and allocations to these asset classes should be kept in context of portfolio strategy and individual risk tolerance.
As we enter into the second half of 2018, it is important to understand the risks that exist in the world, and to apply them to specific goals and objectives. Each individual situation is different, which means the appropriate allocation will be specific to each investor. With so many large, important headlines, it is critical to understand your current allocations and ensure they are aligned with your long-term objectives. If there is too much, or too little risk in your portfolio, it may begin to create dissonance with behavioral influences, negatively impacting strategies and decision making. If you have any questions or concerns about your portfolio, outside assets, or would like to discuss our outlook on the economy, we encourage you to reach out to us and schedule a comprehensive review meeting.
We wish the best to you and your families and we look forward to discussing your wealth strategy and planning opportunities soon.
Warm Regards, Michael Olivia and Bill Combs
Resources: All information was gleaned from publicly available sources and through interviews, conversations and web conferences with the following investment management firms and analysts.
BNY Mellon Wealth Management
City National Rochdale
Disclosures: Michael Olivia and William Combs are Registered Representatives and Financial Advisosr of Park Avenue Securities LLC (PAS). OSJ: 4275 Executive Square #800 La Jolla, CA 92037 619.684.6400. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representatives of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. WestPac Wealth Partners, LLC is not an affiliate or subsidiary of PAS or Guardian. Insurance products offered through WestPac Wealth Partners and Insurance Services, Inc., a DBA of WestPac Wealth Partners, LLC. This Material is Intended For General Public Use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. This material contains the current opinions of the author but not necessarily those of Guardian or its subsidiaries. | Olivia CA Insurance License #0E57168 | Combs CA Insurance License #0I49903 | 2018-63005 Exp. 09/20 Past performance is not a guarantee of future results. All investments contain risk and may lose value. S&P 500 Index is a market index generally considered representative of the stock market as a whole. The index focuses on the large-cap segment of the U.S. equities market. Indices are unmanaged and one cannot invest directly in an index. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies. Investing in foreign securities may involve heightened risk including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws. Such risks may be enhanced in emerging markets. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit, and inflation risk.