Charleston Financial Advisor

Reliance on an Investment Philosophy

August 20, 2019 by Justin M. Follmer, MBA, CFP®, AIF®

“The important thing about an Investment Philosophy is that you have one you can stick with.”

– David Booth, Founder and Executive Chairman of Dimensional Fund Advisors

Last week markets continued their slide as investors fled equities for safer-haven assets like U.S. Treasury Bonds. The buying pressure of US Treasuries caused the interest rates on these bonds to decrease. It’s important to remember that bond prices and bond rates (also called yields) move inversely to each other; as more investors push up the price of bonds, yields will decrease. The opposite happens when investors sell out of bonds and buy equities. In spite of all of this, we believe a reliance on an investment philosophy is crucial.

What’s driving the direction of both bond and stock markets?

Two words: Tariffs, FED.

That’s been the name of the game over the last 18+ months, and at times, I feel like we are repeating the same ole song and dance.

A few months ago, the difference between the 3-month and 10-year Treasury bond yield went negative for the first time since 2007. The financial media took this as a sign of imminent recession; however, we maintained the stance that no recession was in sight. On Wednesday, August 14th, the difference between the 2-year and 10-year Treasury bond joined the 3mo/10yr in turning negative. Economists call this negative difference an inversion of the yield curve. An inverted yield curve has preceded each of the previous 7 recessions. As of my writing this, global stock markets are not taking this news lightly – mid-day Wednesday August 14th, the major US indices are down around -2.75%. However, bond markets are signaling conflicting information.

There are a few components that we are continuing to monitor that may explain this inversion and why it doesn’t necessarily spell doom.

European Economic Weakness

Germany posted its first negative GDP results (-0.1%). Recall that a technical recession is two consecutive quarters of negative GDP. This would fit the narrative of a global economic slow-down. In addition, there’s rumors of trouble with a hard-Brexit plan from the EU. Add these issues to Italian Populist Party concerns and one has the makings of trouble abroad. But the US economy, by most measures, is still relatively healthy. Last Quarter’s GDP decreased to +2.1% from 1st Quarter results of +3.1%; well within the range of GDP reports over the last 9 years.

Market Expectations of Further FED Rate Decreases

Three weeks ago, the FED reduced the Federal Funds Rate after a multi-year period of raising rates. The last increase was December ’18. At that time, I believed (and still do) that the economy did not need that final rate hike. Markets felt the same sentiment that caused the rest of December’s rapid market decline. It wasn’t until the FED signaled a cautionary policy in moving rates going forward (i.e. data dependency) that stock markets rebounded to 2019 highs between January and July. And if by political pressure, the FED essentially removed the December rate hike through its rate decrease last month. The FED called it a “mid-cycle adjustment” however, investors wanted more and still do. The question remains if the recent market turmoil and additional tariff action by the Trump Administration will force the FED to reconsider their stance. We almost have to question if one is driving the other? As of today, the bond markets are pricing in a 100% chance of another 0.25% rate cut in September. This pricing in may be the sole reason for the yield curve inversion. Remember that we believe (1st Pillar of our Investment Philosophy) all available information and expectations of the future are reflected in market prices. If investors are expecting the FED to reduce rates, it only makes sense that current rates would also decrease. Yield Curves have historically inverted due to tight monetary policy – that isn’t the case today. And why is no one talking about the $1.4 TRILLIONS of dollars in excess reserves still flooding the system? US monetary policy is not tight by our measures and some would say it’s simply, less-loose.

Why First Trust Portfolios says “This Is Not 2008”

Tariffs

The Trump Administration recently removed some tariffs and delayed others until Dec 1st. The mixed signals from President Trump explains much of the volatility in recent trading days. To say it has been whipsawed action would be an understatement. Markets were moving higher on signs of progress in trade talks with China but dropped significantly as a result of the inverted yield curve. As I’ve been meeting with clients over the last couple of weeks, I’ve explained the rationale behind why the world needs a successful trade agreement with China. To recap, I believe the global economy will benefit when trade secrets and other intellectual property are protected across country borders. These secrets are crucial to keeping capitalism and free markets alive. There remains an additional benefit to tariffs that hasn’t been discussed much – supply chain transitions to non-tariff countries. US companies with locations in China may be forced to transition their business to neighboring countries where labor costs remain low compared to the US but still comparable to China. If US corporations can strategically exit China to avoid tariffs, the Chinese economy may feel more pain than they are experiencing through a loss of jobs and tax revenue. This could be another pain point for the Chinese needed to force the US and China to meet in the middle on an agreement. The only concern I have here is whether the Trump Administration is ready to give a little ground to gain a lot of ground. If we look to President Trump’s twitter feed, I’m not certain he’s willing to capitulate on any demand. This, in my opinion, would be a mistake; negotiations become successful when two opponents meet in the middle.

Conclusion

We, as advisors, monitor these data points and concerns daily and we must remain focused, diligent, purposeful and unemotional in our approach to wealth management. Looking to the Investment Philosophy and the empirical evidence that is deeply rooted in academic science, each client’s portfolio strategy is designed with their financial goals, risk tolerance, and risk capacity in mind. For this reason, every portfolio is built with economic downturns, stock and bond market corrections in mind. It’s the primary reason we use fixed income assets to soften volatility. Recessions are a part of the economic cycle and avoiding them is not possible. It is highly provocative to imagine a strategy that gets out at the top of the markets and in at the bottom at precisely the right times. Imagine the money one could make and the emotional stress one could avoid with such a strategy? The reality is that such a strategy is impossible for humans to implement consistently and reliably and there is a plethora of data to support this impossibility.

Here’s what we will be/are doing for our clients. We believe that maintaining a consistent allocation to a globally diversified portfolio within your risk tolerance remains the most reliable method to achieving your long-term financial goals. To maintain this consistency, we rely on rebalancing techniques to keep allocations in-check as global markets move. This means that, at times, we’ll sell out of portions of one position and buy into others. We may also replace positions or add positions as necessary to take advantage of depressed prices and/or other opportunities. These actions aren’t meant to time the market, per se, but rather to ensure prudent management of our client’s investment portfolios.

Whether you’ve been a do-it-yourselfer or have been working with another financial advisor, maybe it’s time you consider a second opinion? Our phone lines are open, email inboxes properly filed and ready for your message. We’d love nothing more than the opportunity to sit down and show you why we’re different and how we believe our Investment Philosophy can help create calm during market storms.

Here’s how you can get in touch with us today.

Outguessing the Market

July 8, 2019 by Justin M. Follmer, MBA, CFP®, AIF®

Try outguessing the market. Over the course of a summer, it’s not unusual for the stock market to be a topic of conversation at barbeques or other social gatherings. A neighbor or relative might ask about which investments are good at the moment. The lure of getting in at the right time or avoiding the next downturn may tempt even disciplined, long-term investors. The reality of successfully outguessing the market, however, isn’t as straightforward as it sounds.

OUTGUESSING THE MARKET IS DIFFICULT

Attempting to buy individual stocks or make tactical asset allocation changes at exactly the “right” time presents investors with substantial challenges. First and foremost, markets are fiercely competitive and adept at processing information. During 2018, a daily average of $462.8 billion in equity trading took place around the world.² The combined effect of all this buying and selling is that available information, from economic data to investor preferences and so on, is quickly incorporated into market prices. Trying to time the market based on an article from this morning’s newspaper or a segment from financial television? It’s likely that information is already reflected in prices by the time an investor can react to it.

Dimensional recently studied the performance of actively managed mutual funds and found that even professional investors have difficulty beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs.³

Further complicating matters, for investors to have a shot at successfully timing the market, they must make the call to buy or sell stocks correctly not just once, but twice. Professor Robert Merton, a Nobel laureate, said it well in a recent interview with Dimensional:

“Timing markets is the dream of everybody. Suppose I could verify that I’m a .700 hitter in calling market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not. But if they were, that’s 0.7 times 0.7. That’s less than 50-50. So, market timing is horribly difficult to do.”

TIME AND THE MARKET

The S&P 500 Index has logged an incredible decade. Should this result impact investors’ allocations to equities? Exhibit 1 suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 went on to provide positive average annualized returns over one, three, and five years following new market highs.

Exhibit 1. Average Annualized Returns After New Market Highs S&P 500, January 1926–December 2018⁴

CONCLUSION

Outguessing the market is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence that it can be done reliably, even by professional investors. The positive news is that investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things they can control (like having an appropriate asset allocation, diversification, and managing expenses, turnover, and taxes) investors can better position themselves to make the most of what capital markets have to offer. If you’re looking for a better investment experience, please contact one of our advisors today.

Written by Dimensional Fund Advisors, LP with edits by Coastal Wealth Advisors, LLC
In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.
Mutual Fund Landscape 2019.
In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

Investment Fads

March 4, 2019 by Justin M. Follmer, MBA, CFP®, AIF®

Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment fads and opportunities. Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.”

WHAT’S HOT BECOMES WHAT’S NOT

Looking back at some investment fads over recent decades can illustrate how often trendy investment themes come and go. In the early 1990s, attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan. A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or trends have come into and fallen out of vogue. In the 1950s, the “Nifty Fifty” were all the rage. In the 1960s, “go go” stocks and funds piqued investor interest. Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of information technology and telecommunication services. During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular. In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest rate environment in the following years, other funds sprang up that claimed to offer increased income generation, and new strategies like unconstrained bond funds proliferated. More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered attention among investors. And now that FAANG has had some considerable weakness during 4th quarter 2018, the next investment fad appears to be LUPA – a new acronym for 2019 IPOs of Lyft, Uber, Pinterest, and Airbnb.

THE FUND GRAVEYARD

Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world.

With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.

It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured.

WHAT AM I REALLY GETTING?

When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:

1. What is this strategy claiming to provide that is not already in my portfolio?
2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?
3. Am I comfortable with the range of potential outcomes?

If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, a market portfolio offers the benefit of exposure to thousands of companies doing business around the world and broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio, investors should understand the potential benefits and risks of doing so.

In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals.

Fashionable investment fad approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets.

Article written by Dimensional Fund Advisors, LP with edits by Coastal Wealth Advisors, LLC.

Staying Invested

February 11, 2019 by Justin M. Follmer, MBA, CFP®, AIF®

If we could choose a near-perfect example of why we harp on staying invested and remaining committed to an investment strategy that’s rooted in academic science, it would be the returns that equities experienced during January 2019. After a terrible 4th Quarter in 2018, most global equity benchmarks roared back from their holiday blues.

Here’s where we stand so far (from 1.1.19 through 2.1.19)¹:

S&P 500 Growth	+7.51%
S&P 500 Value	+8.80%
S&P Mid-Cap 400 Growth	+9.73%
S&P Mid-Cap 400 Value	+12.02%
S&P Small-Cap 600 Growth	+8.81%
S&P Small-Cap 600 Value	+12.46%

A keen eye will notice a couple of points with the data above that coincide with our Investment Philosophy and why staying invested was far better than selling out at the end of December. First, Small and Mid-Caps outperformed Large Caps. Second, Value in each market cap outperformed Growth. And while this is great news, it doesn’t mean that we’re now in the clear. In fact, I wouldn’t let any single month of data, either good or bad, persuade you to make any portfolio strategy changes nor would I let it convince you of any strategy other than staying invested.

I highlight the points above merely to show that in any given month, the premiums we target for our clients will either be positive or negative and it’s impossible to predict one way or the other. By staying invested, the goal is to constantly pursue the premiums regardless of our personal outlook. I touched on this topic back in November of 2018 in a newsletter titled “Chasing Premiums;” contact us to be included on future newsletter mailings.

As mentioned above, Value outperformed Growth across market capitalization. Using the Small-Cap results as an example, historically speaking, the amount of outperformance in any given month is expected² to be 0.27% (statistical mean) . In simpler terms, we should expect to have Small Cap Value outperform Small Cap Growth by 0.27%. Holding all else equal, if Small Cap Growth returns 1.00% for a hypothetical month, we should expect Small Cap Value to return 1.27% in that same month. Make sense?

In January 2019, Small Cap Value outperformed growth by 3.65%, well above the expected 0.27%. How can this be? Let’s travel all the way back to statistics class…you know, the class most people hated! Whenever there’s a mathematical mean or average, there’s also a measurement of results spread around that mean; what we call a standard deviation. Using historical data, the standard deviation of Small Cap Value is 2.82%. This signifies that performance of this premium in any given month has shown to be anywhere from -5.37% to 5.91% calculated as 2 standard deviations from the mean. This represents 95% of the results within a normal distribution.

To take this one step further and bring us back full circle as to why we care about this data and why staying invested is preferred to not, think about the following question for a minute. If we expect the premium of Small Cap Value in a given month to be positive (0.27% is a positive number) what percent of observations over the last, say, 10 years, were not? The answer: 4.53% of the observations were negative. Let’s ask the same question for other time periods:

Any given month:	42.68% negative.
1 Year:	29.59% negative.
3 Years:	18.00% negative.
5 Years:	11.68% negative.
10 Years:	4.53% negative.
20 Years:	0.82% negative.
30 Years:	0.17% negative.

Notice a trend? The longer you pursue the premiums by staying invested, the greater your chance of realizing positive premium results.

I’ll reiterate the following point: do not let a single month of data, or even six single months of data, change your outlook and, thus, investment strategy nor let it cause you to do anything other than staying invested. Your investment strategy should be based on your time horizon, financial goals, and tolerance for volatility (risk) and should change only when one of those change. We help guide, manage, and make minor adjustments along the way for our clients and we’d love to help you and your family too. Get in touch today to begin your journey.

Image Credit: MCLB Albany – navigating by use of compass and data – not by gut feelings and emotion.

https://www.ftportfolios.com/Commentary/MarketCommentary/2019/2/4/week-of-february-4th
I italicize the word “expect” on purpose – we expect these results because of past statistically significant observations, they are not guaranteed results. Very little is guaranteed in the investor world.
French, K. (2018) Volatility Lessons: What do past returns say about future performance. Tuck School of Business, Dartmouth College.

When Markets Drop

October 31, 2018 by Justin M. Follmer, MBA, CFP®, AIF®

In the next couple of weeks, investors will begin receiving October portfolio statements from their custodians and may ask themselves what to do when markets drop. If you’re like most investors, you usually don’t take the time to check your account balances daily, online or through your mobile app, but rather only decide to look when you hear bleak headlines on the nightly news. And with recent headlines such as these, we can understand why:

“Stock market experts say this is a stumble, not a plunge”

“U.S. stocks close lower as Dow drops nearly 1,400 points in 2 days”

“Market timers say it’s still too early to jump back into stocks”

“Dow drops more than 1000 points in two days”

Here’s what to do when markets drop:

Understand that articles are written to trigger an emotional response.
Be rational and proactive, not emotional and reactive.
Address “1,000+ point drops” long before they happen.
Either hire an Investment Advisor with a Fiduciary Duty or have a battle buddy.

Journalists have a unique job; they pen headlines that are designed to invoke an emotional response to get readers to click on the article. And when markets drop, the headlines get more wild. More clicks = more traffic = more ad revenue. Let’s illustrate this point with two headlines. Which is more exciting?

“Dow Drops 1,000 points.”

“Dow closes down 3.7%.”

We’re willing to bet the “1,000 point” headline is more exciting for the mere psychological idea that 1,000 is larger than 3.7. But if the Dow is sitting at 27,000, these hypothetical headlines depict the same results, just written differently. While our example above is purely hypothetical, a seasoned investor needs to know when to dig deeper than flashy headlines.

The third principle of Our Investment Philosophy reads:

Emotions are Destructive. Reacting to current market conditions may lead one to making poor investment decisions at the worst times.

Market corrections and other major news events affecting the world tend to alter investor’s outlook about the future when markets drop. When you hear advisors suggesting you take a long-term approach, the advice can feel too cliché and ambiguous. We believe this advice is more about historical evidence and emotional pause rather than an effort to brush off the pain you may be feeling. When an investor is proactive, it means she has positioned her portfolio in a manner paralleled with market uncertainty. Recognize that markets rise and fall as they digest information daily. These movements are a fundamental part of being an investor and should be embraced rather than avoided. It is our opinion that one of the best ways to accomplish this is by having a globally diversified portfolio that pursues your financial goals and is based on your tolerance and capacity for risk. This means that rarely will you be 100% stocks, 100% cash, or 100% bonds. You’ll more than likely be a combination of each through all market conditions. How much of each is outside the purview of this blog post, but we’d love to sit down with you and build a portfolio just for you.

A principle of portfolio design is understanding the long-term characteristics and historical performance of a similar portfolio. While history may not be indicative of future results, it provides some insight into how one’s portfolio may have performed in past markets as well as the variability of returns over time. With this information and an understanding of your financial goals, it’s relatively easy to address 1,000+ point drops long before they happen. Often, the question isn’t about whether these drops in markets will occur, but rather, how much of the drop your portfolio will feel and what your reaction may be in those moments. Will you decided to sell everything and go to cash, will you double-down and buy more, or will you do nothing? We believe utilizing an intuitive risk tolerance assessment is a great starting point towards designing a personalized portfolio that is customized to you and your feelings.

As you plan for your family’s financial future, it can feel daunting to go at it alone. An easy way to address this is by having a trusted friend or partner who you can freely talk to about these personal issues, one you can rely on for accountability when markets drop, and one who goes through the same process as you. In the military, this person is often called a “battle buddy.” If you’re a DIY investor, do you have someone like this that you can rely on?

If not, another way is to hire someone to fulfill this role. An investment advisor with a Fiduciary Duty can not only help you structure your investments for market uncertainty, but also keep you invested when markets drop. It’s easy to hire any financial advisor to implement an investment strategy, but we find that non-investment related issues have a meaningful impact on an investor’s behavior. For these reasons, we believe working with a Fiduciary is the most prudent way to approach your relationship with financial advisors. And that’s precisely why we choose to be Fiduciaries. We’d love nothing more than earning the chance to meet you and learn how we can help make sudden market movements have a more meaningful impact in your life. Here’s how you can get in touch with us.