Whiteford Wealth Management, Inc.
404 Broadway Street, South Haven, MI 49090
Tel: (269) 637-4400 Fax: (269) 637-4407
January 2, 2018
Happy New Year and welcome to our 4th Quarter Update for 2018! In the last three months, we saw one of the worst quarters that we have seen in nearly a decade. In this update, we’d like to shine some light on several of the key issues that we think contributed to this and what our 2019 outlook is. Here is an outline of this update:
- United States Economy;
- European Economy;
- Asian Economy;
- Global Economy; and
- Our Short-Term/Long-Term Goals.
|Name of Index
||Jan. 2, 2018 (close)
||Jan. 2, 2019 (close)
|Dow Jones Ind. Avg.
|CBOE 10-Yr (^TNX)
Please be advised that the percentage change in yields in bonds do not necessarily represent a similar increase in value, it only serves to show you that a substantial change in interest rates has occurred—although it does in fact affect the values of outstanding bonds. Generally speaking, when interest rates rise, bond values fall. Also, many stocks of the DJIA and the S&P500 have dividends which are not included in the NAV’s percentage change on the associated index. Most NASDAQ companies have historically lower dividends but they are also not quantified here.
Let’s compare these figures to our foreign counterparts around the globe. We’ll do so by comparing the major indexes of Germany, China, UK, & Japan.
|Name of Index
||Jan. 2, 2018 (close)
||Jan. 2, 2019
|SSE Comp. (China)
|FTSE 100 (UK)
|Nikkei 225 (Japan)
||23,506.33 (Jan. 4)
||19,561.96 (Jan. 4)
|German Bund (DE10Y:DE)
||0.426% (Jan. 1)
Like before, the percentage change in Bund value is not necessarily reflective of a similar change in value. Also, when interest rates rise, bond values generally fall. We still think that the European landscape is economically too risky for a very large proportion of any of our clients’ savings because of what these rates imply.
As illustrated in the next chart, we had a great couple of years when considering where we started just over two years ago. It is extraordinarily important, with increases in volatility, to take a step back and look what has happened since the beginning of 2016 and the rocky start that we had that year.
|Name of Index
||Dec. 31, 2015 (close)
||Jan. 2, 2019 (close)
Source: Google Finance
Please also look to the following website for MCSI data on all countries listed (click the country tab about 1/3-way down). Look at the YTD and the rolling 1, 5, and 10 year periods.
Clearly, the best country to be invested in since the close of 2015 and even earlier continues to be the United States. There have been and always will be short-lived opportunities within specialized markets overseas; however, we will always continue to invest our clients’ savings with a long-term view. The US market at this point still seems to us to be the best place to do so, so no changes are recommended at this time aside from small inter-account changes that we have discussed with many clients recently.
United States Economy
The fourth quarter of 2018 was the worst single quarter that we have seen in nearly ten years. So why did this happen now? Are US companies really worth 15%+ less than they were just three months ago? This section will be divided into several subsections:
- Financial Fundamentals
- Political Landscape
- The Federal Reserve/Interest Rates
- International Trading
- Financial Fundamentals. 2018 brought upon us the most comprehensive change in the Internal Revenue Code that we have seen since 1986. Reagan was still President at that time! This brought about a slew of changes across the domestic markets in very meaningful and positive ways. We don’t want to belabor the discussion as to how and why it has been beneficial as we have done so in prior updates; rather, it’s just important to note that it had an extremely positive effect on net income for the average American company.
As 2018 unfolded, an extraordinary number of US companies reported greater than the already optimistic earnings that were expected by investors. Even so, many of those companies’ share prices fell as a result of the global market’s downturn. Because of that, valuations are more attractive than they have been in quite some time in our opinion. According to the financial fundamentals that we see, it certainly seems like the time to buy.
- Political Landscape. This should shape up to have a great outcome for investors. The political landscape in this country, according to many new outlets, is in a state of dire emergency. President Trump’s appointees are an ever-revolving door of terminations and new hires. The House and Senate cannot agree on a single thing among themselves, let alone with the President. The Supreme Court was at the forefront of the “me too” movement in the wake of Kavanaugh’s appointment. The trade war that we predicted years ago is unfolding before our eyes. From the average bystander’s point of view, Washington DC is engulfed in chaos and no one seems to know what they are doing.
Even further, the two major political parties have become increasingly polarized, inefficient, and ultimately ineffective. Neither side is ever willing to compromise even in the slightest on their deeply-held beliefs. This has furthered the divide in Congress and DC as a whole. It even led to the most recent Federal Government partial shutdown before the end of the year.
However, there is an underlying factor that nobody seems to discuss in any meaningful way: when the government isn’t working, the private markets are! When DC has stalled and fails to issue new regulations on the private markets, the uncertainty that comes with those regulations also lies stagnant. More certainty in the private markets results in more confident investing of corporate resources. More confident investing typically results in efficient investing thereby leading to greater profits at the end of the day. In an era of decreased tax liabilities and record profits, the future seems bright for the equity markets—especially at currently depressed share prices.
- The Federal Reserve/Interest Rates. The Federal Reserve Chairman, Jerome Powell, recently stated that despite the sluggish US economy—which we are unsure where he finds his evidence—interest rates should be rapidly increased in the coming months and years. President Trump lashed out at these statements publicly. He is certainly not the first President to do so and we tend to agree with his sentiment. Raising interest rates too quickly could shock the markets. It almost certainly will shock retirees and their bond portfolios which will quickly evaporate in the rising rate environment. The broader implications involve corporate balance sheets and the devaluations of their debt holdings—not debt issuances, but corporate debt of one company that is held by another. This asset devaluation could filter into less borrowing power and compound the problem more rapidly over time. However, as corporations pay down debt with increased earnings—which they should—this problem will hopefully solve itself. We are keeping a very close eye on this issue in particular. Rating agencies failed to do their jobs leading up to 2008 but they have been shown to be more effective since then.
Taking a step back, interest rates are still a good deal below their historic averages. Corporations were making money decades ago at much higher borrowing costs. It’s good to keep this in mind going forward as the sticker shock begins to scare some investors. We have simply gotten too comfortable in the last 9 years as corporations and individuals both were able to borrow at historically low rates.
- International Trading. Because we will be discussing the international markets with more specificity in the following sections, we will keep this brief: many news outlets have been reporting that a slowing of the international economy has had detrimental effects on the US economy. This is true. However, what is also true is that those same international economies have been in the gutters for 9 years! Europe began emerging from their gutter in 2017. However, they slumped right back into it recently primarily because of their absolutely awful political environment. Their politics are just as divisive if not worse than our own. The US economy is the largest in the world. California alone accounts for the 6th largest economy globally. We have plenty of economic activity going on at home and that is precisely what brought us out of the 2008 financial debacle. Times were much worse then—this recent downturn should be a piece of cake once investors let it happen.
The rise in nationalism globally has splintered the economic and political union that was established at the beginning of the century. Trade wars, migration crises, and the resulting economic stagnation run amok on the continent. The UK is looking to complete its Brexit this year. France’s yellow vest movement also demands its removal from the EU. Italy’s protests have demanded the same. Spanish protests came to similar conclusions. Poland and Hungary have elected far right political parties to coincide with populist nationalistic rhetoric. Germany is failing to keep the Union afloat as its largest economy. The German people are beginning to get tired of picking up the slack produced by all of its neighbors. The always popular Merkel has begun to lose favor with her constituents.
Europe’s political landscape is a complete mess. There’s infighting between neighbors and even within the constituent countries themselves. On top of that, European powers are not getting along with their Asian counterparts and in furtherance of this the US has begun to use Europe as a bargaining chip in its tariff talks with China and Russia. Times are not looking good in Europe. We predicted that the rise of nationalism would bring about these changes and we have kept away from any investment aside from carefully selected assets there. We will continue to do so.
The Asian economy doesn’t seem to be faring much better than Europe’s. Chinese and Japanese stock indexes are looking feeble to put it mildly. The increasing trade war has hurt both nations for different reasons. Japan is primarily impacted because of its relationship with the US. To remain in good favor, Japan must neglect trade with many of its neighboring countries because the US essentially tells it to do so. China was set back directly by these tariffs and now Chinese companies are scrambling to establish relationships with companies in US-friendly countries so that they may continue trading their goods and services. Involving at least one “middleman” thereby increases costs and decreases profits. Small and medium-sized businesses simply cannot compete. They are being purchased for pennies on the dollar by larger companies so that the newly established out-of-country relationships can be further leveraged. The state of the European economy has also significantly diminished corporate profits in the Mainland.
Further, the People’s Republic of China has been shoring up loose geopolitical ends. These can be easily seen in the cases of Hong Kong, Taiwan, Macau, Xinjiang, and the South China Sea with the many relationships at stake in this critical trading region. Chinese neighbors are also feeling the rise of nationalism. Southeast Asian countries such as Myanmar (Burma), Vietnam, Thailand, and Cambodia are all experiencing quite a lot of political upheaval in their respective governments. Response to such events can be seen in Chinese relations with Taiwan. Taiwanese people have increasingly been fighting back at the Chinese assimilation of their cultural, financial, and political heritage. This has been met with extreme prejudice. Bookstores and other information outlets continue to be closed by authorities. Owners subsequently go missing.
As far as the trade war is concerned, we see some light at the end of the tunnel. There was recently an agreement made in regards to automobile manufacturing. The Chinese New Year is coming up in the first week of February. Just like our own politicians in DC seem to enjoy passing legislation at the end of the fiscal year because of simple, practical rationale, the Chinese people enjoy starting their own New Year off with many accomplishments behind them. We hope that January will show our hypothesis to be correct in a positive way.
At the end of the day, the uncertainty accompanied by an investment into China, Japan, or the rest of Asia as a whole seems to be unwarranted. We will continue to stay away.
The overall global economy is dealing with the rise of nationalism in many respects. We see it in Europe, we see it in Asia, we see it in Latin America, and we see it here in our own backyard. There are many negative repercussions for such movements but history has shown us that there are always opportunities. The last 9 years have made it easy to be an investor. Volatility was extremely low. Interest rates were extremely low. 2008’s crash led to increased productivity among US corporations. Increased efficiencies resulted in increased profits and our companies have essentially taken over the world’s economy like they never have before.
Going forward, we simply must be more astute investors like prior decades necessitated. We must continue to select only the highest quality investments in the highest quality markets. Right now, there is no rationale that we see investing in overseas assets—aside from a few key companies. The only thing scarier than investing overseas seems to be investing in mid and long-term debt markets during a rising rate environment, especially if Powell and the Fed want to scale up the hikes. Cash has not and never will be a good long-term investment so long as the global economy continues to utilize the central banking system.
So, the only investment at this time seems to be the US equity market. With the rise in nationalism comes the rise of corporatism—meaning that larger companies outperform with lower-than-usual risk because of their close ties to government legislators and regulators. We will continue to follow history’s advice.
Our Short-Term & Long-Term Outlook—Conclusion
So what’s next for our clients? Many of these points come straight from the last Market Update, as our long-term goals have not changed.
- Realize that the near-term is going to be a bumpy one as investors all around the world get used to the idea of average returns paired with average volatility. Hopefully the recent increase in volatility rattled everyone back into a normal investor mindset. The last 9 years have made us all spoiled!
- Realize that we have had an extraordinary period of growth. Until things normalize, we must make prudent investment decisions. We have given quite a bit back to the market. Now it should normalize in the other direction but we don’t have a crystal ball.
- Keep a primary large-caps and international mega-caps.
- Begin moving toward a more traditional model of investing. Increasing interest rates means increasing yields on debt instruments. This will offset the expected increases in volatility.
- This should account for 10-20% of the model portfolio at least.
- Continue to stay away from international investments aside from very specific purchases.
- Continue to watch geopolitical tensions and their ugly offspring. If something dramatic happens and we need to make a dramatic move accordingly, we will do so to the best of our abilities diligently, efficiently, and involve our clients in the process as much as humanly possible. Fortunately, the history books have laid out effective strategies for when times like that occur. Unfortunately, they are imperfect in their application to current events.
- Trade wars potentially lead to real wars. We want to be as proactive as humanely possible in this regard. Thankfully, it seems as if more trade deals will continue to occur in the short-term so tensions should die down for now.
Should this brief synopsis of our opinions—and these are purely opinions based on our own analysis of the data—stir any questions about the markets, about our service, or anything else for that matter, please feel free to reach out to us. It takes a great deal of trust to allow someone to manage your life’s savings. The fiduciary duty that we voluntarily assume because of our relationship is nothing compared to the ethical duty that we have to you and your family. It’s not something that we take lightly; so, until the next time we speak, we will be in the boat with you.
Thank you for your continued trust.
Kevin S. Whiteford
Whiteford Wealth Management, Inc.
Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Advisory services offered through Cambridge Investment Research, Inc., a Registered Investment Advisor. Whiteford Wealth Management, Inc. and Cambridge are not affiliated.
This letter is not meant to solicit the purchasing of any equities, bonds, mutual funds, or any investment of any kind. Any direct mention of any investment is meant purely as a reference point in the analysis of the issues discussed in this letter.
These are the opinions of Kevin S. Whiteford and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results. Diversification and asset allocation strategies do not assure profit or protect against loss.