The Legacy Perspective – January 2019
By Steve Wachs, CFP®
“It’s a short trip from the penthouse to the outhouse.”
This quote appeared in last year’s Perspective when we asked the question “are we in for an outhouse season in the investment markets in 2018?” You may recall that we termed the investment performance in 2017 as the “perfect season” and reiterated that perfect seasons are hard to repeat. We predicted a stock market correction (which occurred twice in 2018) and much higher levels of volatility (which was certainly true). For the first 11 months of the year, our predictions were accurate – and then December happened. There was no Santa Claus rally as the stock market indices posted their worst December performance since the 1930’s. Reasons given for the downturn included the Federal Reserve decision to continue their increase of interest rates, the impact of trade relations with China, and the political turmoil in Washington culminating in the government shutdown.
Another quote that we shared last year is that “you can’t predict, but you can prepare.” How did we prepare for this downturn? First, we captured gains prior to the sell-off for future planned distributions so we did not have to sell at the wrong time. When appropriate, we sold some equity positions for income tax purposes that generated losses to offset capital gains from other positions in the portfolio. We reinvested the proceeds from these sales in similar equity holdings. We also stayed consistent with our asset allocation philosophy that limits downside risk.
So what do we see in 2019?
Slower U.S. economic growth. Many companies had record earnings in 2018 which will be hard to replicate. We do not see an economic recession. The graph above it shows that recessions have historically occurred in an environment characterized by commodity spikes, an overly aggressive Federal Reserve, or extreme stock market valuations. With a surplus of energy related resources, we do not see a commodity spike. With the decline in stock prices in December, excess equity valuations are not currently present. Regarding the Fed, their most recent announcement set expectations that rates would be raised only two more times rather than three times in 2019. The term they use for dictating their course of action is “data dependent.” Obviously, if they reset expectations to accelerate rate hikes, we would be concerned.
Inflation will remain tame. An over 20% decline in oil prices has translated into significant reductions in energy related prices including what it costs to fill up your car. The cost of either buying a home or renting appear to be stabilizing. Although employment numbers are strong, wage inflation has not surfaced across the board.
Higher stock market volatility will continue. As the “Volatility and the stock market” graph shows, part of what made the volatility in 2018 seem extreme was the lower level volatility in the previous two years. Uncertainty around trade issues, government shut-down and Federal Reserve decisions are all headline risks that create volatility. In addition, technical trading strategies combined with the rise of passive investing amplify stock market moves. This seems to occur in the first 15 minutes and the last 15 minutes of daily trading.
“Ok” returns for both stocks and bonds. Barring a recession, we would expect to see positive returns for both of these asset classes. With the large decline in December, stocks are generally trading at decent valuations which provides upside return potential. You may recall in the first quarter of 2018, both stocks and bonds fell. Bonds were negatively impacted by the jump in interest rates. Bonds now have higher yields and we anticipate less interest rate risk.
These kinds of predictions are fun, but we don’t put your financial independence at risk based on whether our guesses are right or wrong. Making a bet on what investment will do the best does not work for building and maintaining long term wealth. Allocation among different types of assets based on your specific goals and risk tolerance will provide the best long-term outcomes. Although last year was challenging with most asset classes suffering negative returns, asset allocation minimized the damage to overweighting portfolios to specific sectors or equity categories that were down over 10%. We will continue to selectively rebalance your portfolio which is a disciplined way to “buy low, sell high.” We will make sure your planned income needs are taken care of. We will continue to monitor each of the investment managers or individual stocks we employ. We will use our collective wisdom to keep you on the path of financial independence.