“Economists are pessimists: they’ve predicted 8 of the last 3 depressions” – Barry Asmus
“The only function of economic forecasting is to make astrology look respectable” – J K Galbraith
Dear Clients and Friends:
We have some new faces here at DV Financial. Julie Boulden joined the firm in early February to fill the void left by Sue when she and Matt opened the Altoona office. Julie has been quick to learn our systems and has already made herself a valuable asset to both the organization as well as the clients she has had the opportunity to meet. She has a strong aptitude for technology and is working on getting (and keeping) data in the client portals up to date so don’t be surprised if she reaches out to you to help make your client portal experience better. She is also a notary and will notarize documents for you without charge.
Second quarter also brings us to the end of tax season which is an excellent time to clean out old records. At DV Financial, we use a shredding service to protect your sensitive information and strongly encourage you to shred as well. That is why we allow you to bring in your old records for destruction at no charge. It is important and we want to make it easy for you.
Different Baskets for Different Eggs
There are only two ways to make money with stocks; selling them for more than you paid (capital gains) or generating income (dividends). Of course that really is putting it in the simplest of terms, but it really does come down to those two simple strategies or a combination of both.
Historically, the stock markets have provided returns superior to any other asset class which is why we typically recommend almost everyone have a portion of their portfolio invested in equities. Sometimes people approaching retirement, or in retirement, believe the stock market is “too risky” for them but research suggests that a limited exposure to a diversified and conservative stock portfolio will not only generate some income but also allows for the possibility of growth.
Even though an exposure to equities is not a strategy which guarantees against short term losses, it does mitigate other risks to even a conservative portfolio such as interest rate risk and inflation risk.
While you shouldn’t put all your eggs into any single basket, you should probably some eggs into every basket.
Collective Wisdom and Market Volatility
Have you ever stopped to wonder about how stock prices are determined? I think most investors understand the general idea of the price determining the balancing point of supply and demand, but considerable research has been done as to what influences cause that balancing point, and hence the stock price, to move.
The reality is that stock prices, and this is just as true for an individual stock as it is for a broad based index, are a gauge of market sentiment that takes into account the collective wisdom of all market participants. These participants include everyone from the small investors who rely on their gut instinct to the big institutions and their complex and sophisticated valuation models. Collectively they incorporate all publicly available information and generate what they believe is a fair price for a give stock (or collection of stocks in an index) at that moment.
As sentiment shifts, so do prices. Since information is so readily available and quickly distributed, academics like to say the markets are “efficient”; that is all available information is already built into the current price and there is no advantage to possessing public information (and of course trading on non-public information, or insider trading, is an unfair trade practice and a crime). However collective wisdom can sometimes misprice risk, especially when emotions come into play which is why we avoid trying to time the market. No one has a crystal ball that can consistently identify highs and lows as they are happening.
But that brings us to the ups and downs in the market we have experienced lately – in other words “volatility”. In broad context the declines of just over 10% in the late summer of 2015 and the first quarter of 2016 are not particularly significant. Market corrections happen from time to time, even in a bull market. Which is why managing risk is a realistic goal, but eliminating risk is impossible.
Source: Wall Street Journal, MSCI.com
MTD returns: Nov. 30, 2015–Dec. 31, 2015, 2015 returns: Dec. 31, 2014–Dec. 31, 2015
In the first quarter, there was lots of chatter in the financial media spreading fear that the economy was set to slip into a recession. Any economic pullback adversely affects corporate profits, and profits are a big driver of stock prices.
Recent data does not suggest the economy is especially strong, but it does continue to grow at a slow pace. Yet that is not what stocks seemed to be telegraphing at the start of the year. Fear seemed to override the economic data and there were plenty of issues to fear; worries about China, falling oil prices, and concerns over corporate earnings.
If markets typically process information efficiently, collective wisdom tends to overshoot to the upside or downside and we can’t tell how far from reality we were until we look back in hindsight.
The headlines tend to scream of an impending bear market or even a major market crash. Without providing much solid market analysis based on legitimate data, these headlines are designed to draw viewers. The old news adage, “If it bleeds, it leads”, applies to sensational financial articles too.
China provides an excellent case in point. U.S. Exports to China account for less than 1% of U.S. GDP, but stories about Chinese economic woes just seem to creep into investor psyche and scary headlines. China still has a long way to go, but its economy has avoided the proverbial brick wall. Its currency, the yuan, has stabilized and has even begun to appreciate against the dollar rising to roughly a four month high.
What has been going on in oil has really been counterintuitive and has defied the predictions of most analysts. A significant drop in the price of oil was supposed like a huge tax cut for consumers, fueling spending and growth. Instead, it has been a transfer of wealth from producers to consumers. The oil producers have responded by slashing spending and downsizing employees while consumers have not increased spending.
While filling up your car for half of what it cost only a few years ago is satisfying, we are experiencing economic pain without any economic gain, which has carried over into the broader stock market. Furthermore, the steep decline in energy earnings has pulled down profits for the overall S&P 500 Index and wreaked havoc on high-yield bonds.
That is why the beginning of a recovery in oil prices has helped stocks in general and late spring and summer have traditionally been strong periods for oil. Yet the recovery in oil is fragile. The steep drop in prices since 2014 has impacted production from the more costly U.S. shale fields, but oil output has been far more resilient than many had anticipated thanks to innovations and efficiencies gained in the last few years. However, talk of a deal to freeze or cut production among key global oil producers remains just talk.
The Dollar Dip
Finally, investors are also trying to determine stock prices also have to consider the impact from the recent dip in the dollar, especially for the large industrial companies which do a fair amount of business overseas.
The collective wisdom of the market includes millions of investors, both large and small, quickly pricing new information into buy/sell decisions which reflects in the changing prices.
A stronger dollar is a big benefit to those travelling overseas and helps keep a lid on the price of imported goods. But companies doing business abroad must translate those foreign sales back into more expensive dollars, which hurts earnings. Notably, the rise in stocks in March was inversely correlated to changes in the dollars as investors cautiously anticipate decreased headwinds when multinational corporations begin reporting first quarter earnings.
The Bottom Line
Markets experience periods of tranquility and periods of volatility, much like Iowa weather. Both are easy to predict for longer periods of time (such as it will be a hot summer, or we expect the markets to rise in the next few years) than it is to guess what will happen each day this week. Of course there are many sophisticated and complicated forecasts for the weather and for stocks. I am not a qualified meteorologist, but when it comes to stocks most of the forecasts will turn out to be noise and are best avoided.
You have your financial goals. DV Financial is prepared to help you create a roadmap, or financial plan tailored to your individual situation, to achieve your goals. Until new circumstances arise, it is best to stick with your plan which includes understanding and managing your risks.
As always we hope you’ve found this review to be educational and helpful. DV Financial is here to serve you and I am honored and humbled that you have given me the opportunity to serve as your financial confidant and advisor.
If you have any questions or would like to discuss any matters, please feel free to give us a call.
Art Dinkin, CFP®