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2018 2nd Quarter Review: Plenty of Siren Songs

In Homer’s book The Odyssey, Odysseus is counseled about how to avoid the perils on his upcoming journey home. He is warned that, as he passes the island of the lovely Sirens, his men should plug their ears with beeswax because the Sirens’ song is so tempting that many travelers have gone towards them and crashed their boats and died. If Odysseus wants to hear their beautiful song, he must have his crew tie him to the mast and not be released no matter how much he begs. The Sirens’ song contains promises of revealing the future and is so tempting that only being prepared in advance and physically restrained can keep Odysseus from the same downfall others have experienced. You can probably see where I am going with this, as it relates to current market and economic conditions.

Today, I read and hear the siren song of prognosticators who are calling for market drops, riches of crypto-currencies, or other potentially impactful events. I can’t help but think that Odysseus was a little foolish to even want to hear the song and how much better it was to be a crewmember with beeswax in his ear and just performing the many rigorous tasks required to sail the ship. As investment managers, there are announcements and trends that are critically important to watch for and listen to, such as earnings, inflation, actual policy changes, and valuations. Likewise, there are plenty of distractions that aren’t particularly helpful and may just be today’s siren song which will pull us away from our objective. This year has been full of events and news. Here is our attempt to summarize what happened this quarter and year to date, as well as what we view as critical to “sail the ship” going forward.

Source: Blackrock Benchmark Returns Comparison June 2018/ Bloomberg

US Stocks

The volatility continued in the second quarter in the US stock market, but with mostly an upward trend. It is very easy to get myopically focused on each data point of news and miss the main fact that the U.S. economy is indeed heating up, not cooling down. There is some debate, of course, about how much longer economic growth can continue, but the near term is showing strong growth in company earnings, wages, employment levels, and overall business and consumer optimism. The volatility this quarter and going forward continues to be sharply focused on the issue of trade. The term “trade war” is thrown around a bit too much in my estimation, but certainly, negotiations and movement are occurring. The U.S.’s economy gets only 8% of its GDP through exports, while the Eurozone gets 16%, Japan 14%, Mexico 35.6% and China 19% to name a few. It is too soon to tell how much any movement might impact the U.S. economy and whether these changes will be beneficial or harmful.

The Trump administration has seemed to take a much different approach than previous administrations and does not prefer multi-lateral deals. Instead, they are wanting more unilateral deals on trade, military cooperation, and other political support/alignment with US policy. It is not surprising that many other countries don’t like change or disruption, especially since any movement towards the U.S. position may not help their economy. The S&P 500 ended the quarter up 2.65% year to date thru June 30. The index doesn’t tell the whole story as consumer, technology, and energy stocks have had very good performance thus far, while financials, industrials, telecommunications, and consumer staple stocks are negative for the year. Trade policy and interest rates are having very different impacts on the many different sectors of the market. Being aware of these issues and keeping a steady hand will continue to remain important. The smaller companies represented by the Russell 2000 fared better than the S&P 500, due to their having less exposure to international markets, and were up 7.66%. We believe that U.S. stock valuations, in general, remain close to “fair value” and are not showing major signs of being overpriced.

International Stocks

The developed foreign markets represented by the EAFE index have moved in virtual lockstep with the U.S.’s S&P 500 this year, being positive until around the last week of May. Trade tensions caused waning optimism, although company earnings, declining unemployment, and growth in manufacturing remain at strong levels. The U.S. dollar has increased modestly in value against other currencies, which has been the primary drag on international returns. While the EAFE index ended the quarter down -2.4%, it must be noted that -1.8% was due to currency changes. International stock valuations and fundamentals remain at attractive levels relative to history, but we are carefully watching any changes that might be occurring. As long-term investors, we must be patient and rely most heavily on valuations, but as John Maynard Keynes once stated, “when the facts change, I change.” Since trade negotiations and policies are only in the beginning phases, we will remain vigilant in assessing the data that matters most.

Emerging Markets      

Emerging Markets for many are a lesson in patience and determination. As an asset class, it has about 50-70% more volatility than the S&P 500 and, because of that, many investors are tourists in the asset class … they come for the sights when conditions are good but are quick to leave at the first hint of bad news. With tremendous performance in 2017 (up 37.28%), political uncertainty and trade policy in flux, and an increasing U.S. dollar, the Emerging Markets Index had performed similarly to the U.S. market but started to drop in early May. Again, similar to developed market stocks, it appears that currency (the dollar strengthening against their currency) was attributable to most of this move. The fundamentals and valuations of Emerging Market stocks remain attractive and, while we aren’t tourist in this asset class, we do only maintain a small position, as we recognize that volatility will continue to accompany these investments. The Emerging Markets Index ended the quarter down -6.66% for the year (-3.8% of that due to currency moves).

Bonds

The Federal Reserve has been slowly raising short-term interest rates over the last few years and raised 0.25% in March, followed by another 0.25% on June 13th. These rate increases are based on the Fed’s view that economic growth will remain steady and unemployment and inflation targets have been met. As long as these factors remain stable, this slow and measured pace of rate increases is expected to continue for another few years. The rate on the 10-year Treasury bond moved approximately 0.20% this quarter and was 2.9% on June 30th. The 30-year Treasury bond remained at 3.0%. Rate increases are obviously a slight headwind for bond investors, but we also know that, with increased volatility in stocks, bonds remain a critical diversifier for our portfolios. One thing that is occurring in slow motion is the “flattening of the yield curve” (short-term rates are approaching long-term rates). An inverted yield curve (short rates higher than long-term) is often a predictor of an economic slowdown or recession, so we will remain cautious, but we do feel that there is so much government intervention in the bond market (worldwide, not just in the U.S.), that the yield curve alone can’t be used as a bellwether as in the past. The U.S. Aggregate bond index ended the quarter -1.62%, the short-term (1-3 year credit) bond index 0.11%, and the high yield bond index returned 0.32%.

Insert the Beeswax

Like sailors on Odysseus’s crew, we must plug our ears, or at least tie ourselves to the mast of our investment principles, to avoid the emotional pull of so many headlines and market predictions. Oftentimes, headlines are misleading or other pertinent information is left out. We believe that fundamentals and valuations will provide the best information with which to make thoughtful investment decisions. We also know that the status quo can change, so carefully studying our investments and portfolios to have appropriate adjustments in mind is a worthwhile endeavor, even in the midst of mostly positive data. We appreciate your trust in us as a steward of your capital and will continue to focus on a safe journey to your long-term destination.

 

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 5, 2018, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Bridgeworth, LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not ensure against market risk.

Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass.

Reliance upon information in this material is at the sole discretion of the reader.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments.

The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments.

Any securities, indices, and other financial benchmarks shown are provided for illustrative purposes only and reflect reinvestment of income, dividends, and other earnings. They do not reflect the deduction of advisory fees. Investment products are subject to investment risk, including possible loss of the principle amount invested. You cannot invest directly in an index.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.

The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa. Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.

The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.

Barclays 1-3 Year Government Bond – Barclays 1-3 Year Government Bond Index is a market value-weighted performance benchmark of investment grade government and corporate bonds with maturities of one to three years.

The Markit iBoxx USD Liquid High Yield Index is designed to reflect the performance of USD denominated high yield corporate debt. The index rules aim to offer a broad coverage of the USD high yield liquid bond universe. The Markit iBoxx USD Liquid High Yield Index is rebalanced once a month at the month-end (the “rebalancing date”) and consists of sub-investment grade USD denominated bonds issued by corporate issuers from developed countries and rated by at least one of three rating services: Fitch Ratings, Moody’s Investors Service, or S&P Global Ratings.

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