Letter to Clients: 4th Quarter 2014

Dear Clients and Friends:

 

“Everything changes and nothing stands still” – Heraclitus 535 BC – 475 BC

 

There has been a lot of change at DV Financial over the past quarter. To begin with we have moved to a new office at 2763 86th Street in Urbandale, right behind the Panera Bread. If you are available, please join us for a come-and-go open house on Veteran’s Day, Tuesday November 11th from 4:00 pm to 7:00 pm. We will have refreshments, door prizes and more. Bring a guest as we would love to show you our new, improved, facility. RSVP requested, but not required, at http://goo.gl/3wL9ro or http://www.eventbrite.com/e/dv-financial-open-house-tickets-13746103967.

Another big change for us has been the introduction of some new software we hope will allow us to bring client service to a new level. One feature of our new system is the ability to print forms with all your information prefilled, which should save you time when we have paperwork to complete. Please understand if we ask to spend a minute or two making certain the information we have on file is up-to-date. A little time invested now can save lots of time in the future.

 

How healthy is the economy?

There are many tests that can be run during an annual physical, but the simple measures like blood pressure or cholesterol count give a good indication of general health. Similarly, there are basic ways to assess the financial health of a firm. Tracking the price of a stock in relation to its industry peers and in relation to the broader market is like taking the company’s financial pulse. A country’s currency can also be evaluated in basic ways. Weakness can suggest anything from economic problems to political unrest. Conversely, a strong currency suggests economic might, or at a minimum, an economy that is outpacing its peers.

Recently, the dollar has surged in relation to its peers. The Dollar Index, which is a weighted average of the currencies of the nation’s major trading partners, has risen to its highest level in over four years. There are two major reasons we’re seeing a resurgence of the U.S. dollar and it may bode well for stocks and the economy.

MTD %

YTD %

3-year* %

Dow Jones Industrial Average

-0.32

2.81

16.02

NASDAQ Composite

-1.90

7.59

22.99

S&P 500 Index

-1.55

6.70

20.35

Russell 2000 Index

-6.19

-5.32

19.59

MSCI World ex-USA**

-4.34

-2.85

9.97

MSCI Emerging Markets**

-7.59

0.26

4.52

Source: Wall Street Journal, MSCI.com *Annualized **USD

First of all, the U.S. economy is expanding at a faster rate than many developed nations. Growth attracts foreign cash as investing opportunities multiply. In addition, for investors looking to park cash in safe, interest-bearing investments, our favorable rate advantage is also a magnet for capital. Yes, short-term rates are near zero, but U.S. in bond yields have the advantage as the difference between longer-term Treasury bond yields and yields in a number of developed nations widen. Meanwhile, there has been no shortage of talk from the Fed that an eventual hike in interest rates seems destined to occur next year.

It’s a different story in Europe and Japan, where economic woes may encourage their respective central banks to increase monetary stimulus, keeping rates at rock-bottom levels for quite some time.

 

The dollar’s effect on stocks

Conventional wisdom suggests a stronger dollar will make exports less competitive and reduce revenues from sales overseas that are translated back into dollars. Yes, it’s a headwind for individual companies, but research by RBC Capital and the Schwab Center for Financial Research (SCFR) suggests the market as a whole won’t be hindered by a strong dollar.

RBC pointed out that a stronger greenback has historically been supportive of higher price/earnings ratios while SCFR notes that the S&P 500 Index has performed nearly twice as well during dollar bull markets vs. dollar downturns. It’s not that stocks have fallen during dollar weakness; they just haven’t performed as well.

For now, the dollar is enjoying its day in the sun. There will be winners and losers across the economy, but let’s not discount the possibility that as a whole, the U.S. economy and the market could be the big winner.

 

The financial news channel

Take caution about spending too much time in front of the financial news channels dotting the cable landscape or the many Internet sites that are just a mouse click away. It’s not that they don’t report hard news. They do. But there are times when markets get volatile and the “shrillness meter” hits alarming levels.

As we start the fourth quarter, we are seeing wild and tremendous swings in the market. Should you listen to the financial media and join the selling frenzy? Here are some of the headlines from earlier this year when the Dow dropped over 300 points in one day:

  • “Warning: the Plunge in Stocks Is Just Beginning.”

 

  • “S&P 500 Suffers Largest Weekly Loss in 2 Years.”
  • “3 Market Warning Signs that Predict a 20% Tumble.”

These stories play on the fears of investors. Simply put, bad news sells. It can be confusing if the noise isn’t filtered. Keep in mind that it has been over 570 days since we’ve had a 10% drop in the S&P 500 Index, or a decline that would officially be called a “correction.” Going back to mid-1940s, the median time period between corrections has been 121 trading days, and the average has been 273 trading days.

Markets never move up in a straight line and we are due for a 10% pullback which, coupled with the expanding economy, would be healthy. No one can accurately predict when that might occur and one day it will. However, we recommend keeping a long-term time horizon focused on your ultimate financial goals and to make adjustments that take into account changes in your personal circumstances, not fear-mongering that can be deafening during market volatility.

 

What we are watching

Even as the Fed appears poised to start tightening, interest rates could remain at historical lows for the foreseeable future. Meanwhile, the European Central Bank is increasingly discussing more monetary stimulus.

Corporate earnings are rising, the U.S. economy is growing, and companies continue to repurchase shares which not only represents confidence but a real demand for equities. Yet the skies are never completely clear.

The Fed’s low rate policy has encouraged a reach for yield, and hundreds of billions of dollars have gone into low-quality, high-yield debt. Typically, a stronger economy is good for bondholders because it makes it easier for debt-laden firms to pay down debt and meet scheduled interest payments. However, a strong economy could prompt the Fed to hike rates, which could lead to rising defaults, especially among companies that have high leverage and low bond ratings.

In a perfect world, we’d have a seamless hand-off of the baton between the Fed’s decision to raise rates and a stronger economy and faster earnings growth. But we don’t live in a perfect world, and that brings about volatility.

In recent years, there’s been a very close correlation between performance in junk debt and stocks. But so many variables go into the stock-price equation such as earnings, dividends, economic expectations, corporate stock buybacks, and monetary policy by the Fed and major global central banks. Rising profits and an improved economic outlook can be a tailwind for stocks. What’s going on in the bond market matters and is worth watching.

 

What this means for you

While I hope this review is both educational and helpful, it is a general overview of a very complex market. Your particular financial needs and circumstance should be the cornerstone of your financial plan, not external market forces. I am here to advise and assist you. If you have any questions, concerns, or your financial situation has changed since our last meeting please call and schedule an appointment and let’s have a personal discussion.

Last quarter I pointed out that it is easier to stay committed to your plan when the market is moving higher. If we focus on the horizon, I believe the markets will reward patience and persistence although the path may not be smooth and without temporary setbacks. Financial discipline is required to achieve your success.

As we approach the holiday season, it is always a good time to reflect and offer gratitude. I am honored and humbled that you have entrusted me with your finances. I hope to see you and your guests at the open house on November 11th if not sooner.

Sincerely,

Art Dinkin, CFP®