The four most dangerous words in investing are “This time it’s different.” - Sir John Templeton

Overview

If the first five months of the year are an indication of what’s to come, we might be in for a volatile second half of the year.   The strong gains of January quickly evaporated in February and March as fears of a trade war – particularly with China – began to dominate the headlines.   As of this writing, the financial press is reporting that tariffs between the two countries “are on hold,” according to US Treasury secretary Steven Mnuchin.

This has been a long and sustained economic recovery of nearly 10 years, far longer than the average expansion of approximately 39 months (Investopedia).  One of the hallmarks of the economic and market recoveries since the Financial Crisis has been the extended nature of each segment of the recovery.  Think back to the early part of the recovery; it was referred to as an “L” shaped recovery – meaning basically not much recovery at all.  A dramatic drop in economic and market strength followed by a subdued economy that still hasn’t sustained consistent growth over 3%.   This slow but steady growth has been remarkably consistent and many economists expect it to continue into 2019 (Federal Open Market Committee Projections, 3/21/18).

Interest rates also have stayed exceptionally low for a long time.  About the time the media and strategists were touting “lower for longer” in mid-2016, interest rates finally bottomed on the 10-year Treasury at roughly 1.37%.   Since that time, rates have slowly but steadily climbed to about 3.1% today (Thompson ONE Financial data services, as of 5/29/18).

Because of these prolonged portions of the economic cycle, we believe many investors have lost sight of the fact that the cycle itself has followed traditional recoveries.  Take inflation and interest rate expectations, for example.  Traditionally, once inflation expectations bottom and begin to climb, traditional income-based investments often experience subpar performance.   This stands to reason, as a unit of income in an inflationary environment is worth less in the future than today because it loses purchasing power.  So, what has happened with income oriented investments since July ’16?  The Barclays Aggregate Bond index has declined (price only) 7.1%, S&P US REIT Index is down 12.3% (price only), and Alerian Master Limited Partnership Index is down 19%.  All this has happened in a period where the S&P 500 Index price return has gone up 31%. (Thompson ONE Financial data services).

The point is, this is classic later economic and market cycle activity (Richard Bernstein & Assoc.).  What tends to do well in the portion of the cycle? The S&P 500 Financials (+54%), S&P US Industrials index (+35%), Bloomberg Commodity Index (+24%) are examples of the late cycle sectors that we believe make sense to favor.  Of course, this part of the cycle will pass as well, and we will do our best to keep portfolios positioned appropriately.

Why Growth Matters

There continues to be much talk about the recent tax cuts, the long-promised infrastructure spending plan and deregulation.  Intelligent people have very different opinions on these issues and we hear both sides of these debates from clients.   All of these issues spill over into the conversation about the National Debt.   Take a look at the chart below.  Mandatory spending (things that are not negotiable without changes to law) plus interest on the debt make up 76% of the Federal Outlays.  Include defense, and you are now at 88% of budget.  That means that all of the budget fighting is really over 12% of spending – yes, that means we have a problem.  

Source Agri-Pulse Communications, Inc.  May 29,

It is really hard to balance a budget when only 12% of expenditures are on the table.  One of the only viable solutions: grow the economy faster than anticipated and as a result increase revenues.  Tax policy, budgets & appropriations all matter but none of them can solve the deficit issues except growth (Rick Santelli, CNBC 5/21/18). 

Portfolios

Our model portfolios continue to be overweight equity and underweight fixed income.  We also have a meaningful position in commodities in models.  Within equities, we have a slightly higher weighting to international than domestic stocks.   This is driven in large part by the historically wide valuation gap between US Stocks and International stocks.  Currently, the forward PE ratio of the US Market is 16.6% vs Non-US stocks at 13.1% - nearly a 27% premium.  Historically US stocks have traded at a premium to foreign stocks but the premium has generally been in the 5-10% range (Yardeni Research, Inc.).  If these ratios revert to the mean, foreign stocks appear attractive to us.

Final Word

Many of you are aware that Steve’s wife is battling a serious illness.  I’m happy to report that treatments and surgery have gone well and the results from tests has been encouraging.   Please continue to keep the Altman family in your thoughts and prayers.

As always, we appreciate your support and trust.

Brett, Steve & Becky

"It’s better to know how to learn than to know". – Dr. Seuss

Happy 2018!  For investors, the New Year has kicked off in grand style with the S&P 500 up over 6% as of this writing.(1) The market action has been explained by the media as a “melt up” or a “FOMO rally” (fear of missing out).   Regardless of what you call it, the rally has been broad based and very powerful.  In this letter, we will attempt to spell out what we view as the strengths of the rally, what concerns us, and how & why our portfolios are positioned as they are.

The Backdrop

As 2017 came to a close, fewer global economies were in recession than at any other time in modern history.(2) Europe is humming, Japan seems to have finally emerged from a nearly 30-year recession, emerging markets have once again been a catalyst for growth and the US continues its nearly 9-year economic expansion.   Clearly this coordinated growth and related strong corporate earnings have fueled global equity markets.  The US reduction in corporate tax rates is just the latest fuel added to this mix.

Richard Bernstein, who we follow very closely, often says, “’Good” or “bad” doesn’t matter; markets care about “better” or “worse.’”  So perhaps the right question to ask is “can things get much better?”  Time will tell on that, but we know that some elements which may eventually provide a head wind to the market are beginning to show.  Interest rates appear to be going up as the yield on the 10-year Treasury bond has moved from a low of 1.33% in July 2016 to recently over 2.65%.(3) Higher bond yields present competition to stock investments.  The Fed raised interest rates three times in 2017 and are suggesting three additional hikes this year are likely.(4) While the Fed is suggesting they are not necessarily tightening monetary policy - instead normalizing it – the fact of the matter is higher rates eventually slow economic growth.

We have written several times about the fact that this rally has been widely under-owned and discounted by investors of all types: funds, institutions and individuals as evidenced by Merrill Lynch’s Sell Side Indicator.  Since the financial crisis, this indicator has regularly shown an excessive amount of bearishness on the part of investors(5) – a historically positive contrarian indicator for the market.  Indeed, as investors have been overly pessimistic, markets have moved consistently higher.  Recently, this indicator has indicated that the pessimistic phase may be over as investors have improved their outlook markedly.  This could be an early sign of a change coming.  Consider what Warren Buffett has said of his investment philosophy, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. 

The duration of the economic expansion and the stock market advance are clear, both have been in full swing since 2009 – a full nine years.  However, what has the markets return been over the past 10 or 20 years? It all depends on where you start comparing from.  For example, from its low in March of ‘09 the S&P 500 is up over 300%, an incredible move.  But, from its peak in March of ’00 it is up only 78% over the past 18 years roughly 4.5% per year – not that great.(6)   My point is that returns are often a matter of perspective.

 Our Approach

We remain confident in our approach that utilizes the 50 & 200 day moving averages to detect trends in a variety of asset classes.  This approach has caused us to overweight equities and underweight fixed income for the vast majority of the past 5 years.(7) When you think back to all that has occurred over that time, from terrorism to nuclear threats to unpredictable political environments it was very tempting for clients to want to move to the sidelines.   Of course, in hindsight, that would have been the wrong move.   Our gut instinct was often to reduce equities in our models, but our belief in our process caused us to sit tight and hold even when it was uncomfortable to do so.  No approach is perfect – ours included – but following our discipline has allowed us to get our fair share of the upside of the market while having a specific sell strategy when things start to get break down. 

Looking back on the last meaningful downturn in the market is helpful in understanding our process.   In July of 2015 our moderate model was approximately 67% equity, close to the maximum we can go in stocks.  That Summer Russia invaded Ukraine and the markets started to get jittery. By the end of July, the moving averages had broken down for our European holdings as well as our International holdings.  In August, we started the month at 54% equity and in September one equity class after another broke down so that by mid-September we were down to 35% equity in accounts.(8) People forget that by February ’16 the S&P was down over 15% from its recent high.(9) In contrast, our moderate accounts were generally off not more than 6%.(10) Clients were not happy to be down and neither were we.   But, coming back from being down 6% is much easier and quicker than coming back from being down 15%.   We tell clients all the time, by the time the markets break down you will wish we had sold earlier and so will we.  But, the fact is that our process has done a good job of getting out of harms’ way in a timely manner and has provided the discipline to stay invested even when it was uncomfortable to do so.

Current Positioning       

We are at or near maximum levels of equity in each of our models.  We are also at or near minimums in fixed income in each of our models.  Alternatives are neutrally weighted per our benchmarks.  Within equities we are more overweight international than at any time since we founded TRUE.  Over half of our equities are now international – a reflection of better foreign economic growth rates as well as persistent under performance of international equities until last year.   We think that this combination of factors bodes well for the out performance of international stocks for the next several years. 

Another area that we think looks attractive are commodities.  With coordinated international growth, it stands to reason that increasing utilization of commodities is likely to occur.   Additionally, because of the poor returns of the commodity complex over the past decade or so, this asset class has not garnered much interest from investors.(11) We believe that could change; being in the asset class early may be beneficial.

2017 Tax Reporting Statements

Year-End Investment Reports, as well as 1099R and 5498 Forms for IRA accounts (Traditional, Rollover, Roth, SEP) are now available online.  If your document delivery preference is US mail, you should receive them in about two weeks.

For all other accounts, tax statements will begin to be available mid-February.  For most accounts, 1099 tax statements are posted online and/or mailed by February 15th; however, a limited number of forms for accounts that hold mutual funds pending reclassification, or certain complex securities including unit investment trusts, mortgage pool securities, and real estate investment trusts are mailed and posted online by March 15th (contingent upon Fidelity’s receipt of a mailing deadline extension from the IRS).  This later mailing cycle minimizes the need for corrected tax forms.  If you have not received your tax documents by the end of March, please let us know.

Perspective

Some events in life just stop you in your tracks.  We have had three of those in the first few weeks of this year that have profoundly impacted our family here at TRUE.  Events like this are reminders that life is precious and fragile, and encourage us to appreciate those people who are important in our lives.   Please take the time to tell your loved ones you love them and don’t take anything for granted.

In gratitude, 

Brett, Steve & Becky

1,3,6,9,Capital markets data provided by Thomson ONE®

2 TheoTrade Analysis Team, TheoTrade, LLC, 2018 Expected To Have The Fewest Countries In A Recession Ever,Fx Street (Nov. 13 2017).

4 Merrill Lynch RIC Report® (Jan. 9 2014)

5 Merrill Lynch Sell Side Indicator (Dec. 1 2017)

7,8 TRUE Davis Altman Investment Committee

10 Model performance calculated by Envestnet® Performance represents the results of actual trading in a representative account managed according to TPWA’s investment strategy for the time period January 1, 2013 through December 31, 2017.  Results reflect the deduction of a model advisory fee, transaction expenses, the reinvestment of dividends and interest, and internal expenses of investments.  Actual results of TPWA clients managed according to this strategy varied materially, and there is no assurance the same or similar performance would be obtained.  Returns represented are for illustrative purposes only.  These materials are provided by True Private Wealth Advisors, LLC (“TPWA” or the “Firm") for informational purposes only and may contain content that is not suitable for all investors.  No portion of this commentary is to be construed as the rendering of personalized investment, tax or legal advice.  Past performance may not be indicative of future results and may have been impacted by market events and economic conditions that will not prevail in the future.  There can be no assurance the views and opinions expressed in this letter will come to pass.  Investing involves the potential for gains and the risk of loss, and diversification does not necessarily guarantee profitability or protection from declining markets.  Certain information included within is derived from third-party sources that TPWA believes to be reputable; however, the Firm makes no representations with regard to the accuracy or timeliness of such information and assumes to liability for any resulting damages.    

11 Richard Bernstein Advisors – Insights Dec.2017

Equifax Incident

Last week, one of the big four credit reporting agencies, Equifax, announced it experienced a security breach resulting in criminals accessing personal information of approximately 143 million Americans between May and July of this year. The compromised information included names, addresses, Social Security numbers, and dates of birth. In some instances, driver’s license numbers, credit card and credit dispute information were also compromised. This information is nearly everything that is needed to open an account in your name.

TRUE does not have a direct relationship with Equifax, but due to the sheer size of the breach, we felt it important to reach out and let you know what you can do to protect yourself.

• First, visit the Equifax breach website at www.equifaxsecurity2017.com to determine whether you have been impacted. Keep in mind that the full impact of this breach may not be known yet, so consider revisiting the site periodically for the next few weeks.

• If you are impacted, consider placing a freeze on your credit with all of the following credit reporting agencies. Freezing your credit is the only way to prevent those with your personal information from opening accounts in your name.

  • Equifax: https://www.freeze.equifax.com/Freeze/jsp/SFF_PersonalIDInfo.jsp

  • Transunion: https://freeze.transunion.com/sf/securityFreeze/landingPage.jsp

  • Innovis: https://www.innovis.com/securityFreeze/index

  • Experian: https://www.experian.com/freeze/center.html 

• Consider obtaining credit monitoring services. Equifax is offering free credit monitoring to all Americans, whether impacted by the breach or not. Several companies also offer similar services for a fee. Please note that credit monitoring does not prevent ID theft; it simply alerts you when events occur that may impact your credit.

• Be on high alert for impersonators or phishing attempts by fraudsters. Be on the lookout for emails that appear to be from these companies, telling you that you’ve been impacted, or otherwise creating a sense of urgency, and to “click here” for more information. When in doubt, do not click the link. Any legitimate company will have another way for you to contact them to be sure the email is safe.

As always, thank you for your business and trust. If you have any additional concerns, don’t hesitate to reach out directly.

Brett, Steve & Becky

“There are three kinds of lies: lies, damned lies – and statistics”. – Benjamin Disraeli

Markets

It is always hard to know where we are in a market cycle at any given time.   Given today’s unpredictable political climate and geo-political risks, it makes it even more difficult.  And it becomes even more confusing when so many economists “data mine” economic reports to justify their view.   We feel like it is important to provide some color around what seems to be a sense of caution creeping into the market.  Indeed, in today’s headline crazy environment the same report will be used to support both a bullish & bearish view on CNBC.  For example, is the market over-valued?  

• Goldman Sachs issued a report in late July that suggested the forward P/E multiple of the S&P 500 has risen by 80% since 2011 and the trailing PE ratio of 22.1 is well above the 10-year average of 16.7%.   Sounds pretty scary, right?  

• Richard Bernstein points out that average rolling 5-year annualized returns for Bull Markets is 21.4% but the current return is 14.8% which, far short of typical bull markets final run.  He argues strongly that the three primary investment factors are profits, liquidity and investor sentiment - all three of which are constructive in his view.

Two very highly regarded sources with very different views.   In times like this we think it is useful to understand what is “normal” in relation to the market.  According to Forbes:

• Since 1950 there has been ONE stock market crash (defined as a 50% correction or more) and that was during the Financial Crisis of 2007-08.  The S&P 500 traded down more than 50% from its peak for 21 trading days.

• The next most significant correction in the past 70 years was during the Technology Bubble of 2000-02 when the S&P 500 bottomed out -49.15% from its prior peak.

• On average the S&P 500 corrects -10% about once per year, and -20% once per 3.5 years.

Human nature tends to take our most recent experiences and extrapolate them out into the future.   In the case of the stock market, because we’ve had two nearly 50% corrections in the past 15 years, many investors are sure the next “big one” is right around the corner.  Perhaps a better perspective is that while volatility - even to the extent of 20% corrections - is normal, a 50% type event is exceptionally rare. 

Of course, there is no way to know for sure.  That is why we continue to follow our Moving Average discipline across all asset classes. This quantitative and objective method has done an effective job of helping us scale clients’ exposures to different asset classes quickly in changing markets.  We are confident it will continue to do so in the future.  While no process is perfect, using a quantitative method removes emotion and allows for real time decisions to be made.

Year End Preparations

It seems bizarre to already be talking about year-end items but we are on the front end of the planning cycle for that stuff.  Here are some things that we will be talking about with clients in the next couple of months:

• Tax loss selling, off-setting gains and losses, etc.;

• Gifting strategies to both family and charitable enterprises;

• RMD’s coordinating with any qualified accounts you hold outside of TRUE;

• Reviewing and updating your financial plan.

As always, we appreciate your continued support of TRUE and the Davis Altman Group.   If there is anything we can do better to improve your satisfaction, please let us know.

Enjoy the last bit of Summer!

Brett, Steve & Becky