Predicting the Future Archives

Are you a Trader or Investor?

February 11, 2022 by Justin M. Follmer, MBA, CFP®, AIF®

In a world with constant information overload, sometimes it’s best to take a step back from financial news feeds to focus on core topics that drive home the fundamental components and experiences of being a long-term investor. I don’t need to explain to anyone that it isn’t easy being an investor. However, I believe it’s much harder to be a trader.

Allow me to explain.

A trader tends to rely on short-term, one-off theme-based events to drive their portfolio allocation decisions. They rely on timing the market with the goal of outguessing, and thus outperforming, a benchmark.

An investor tends to view those same events as statistical data and routine (standard) deviations. I, and many others, simply call it noise. An investor typically doesn’t allow this short-term “noise” to drive portfolio allocation decisions. Naturally, I’m making some generalizations since not all traders and investors fall into these categories.

Trading requires constant attention with an ability to guess accurately and consistently over time. Volumes of academic research exist to counter the belief that someone can accomplish this profitably. Trading and market timing strategies must be correct more than just once. An example of this would be selling at the depths of the COVID slump during March of 2020 with the goal of preventing further losses. But when does one buy back in…weeks or months later when things seem better? The 2nd worst performing day of 2020, March 12th, was immediately followed by the 2nd best performing day of 2020 (source). Think about that for a moment…by the time the trades settled the next day, one would have missed the rebound. Missing just a few of the best performing days, days that typically occur shortly after the worst performing ones, can significantly impact portfolio performance and value (source).

Investing is an opposite strategy because it relies on the belief that current market prices reflect all available information and expectations of the future. By that definition, it means that it is impossible to outguess the direction of the markets. Our Investment Philosophy is based on these beliefs. As advisors to our clients, we strive to not let the daily noise of markets impact how we design, implement, and rebalance their portfolio(s). It is the reason why our clients remained invested during March of 2020 and the various market corrections we experienced before then and since (i.e. January 2022).

Because we believe there’s no accurate way to guess which way the markets are going to go, we rely on decades of academic evidence to guide portfolio design. This belief, combined with individual investment and financial goals, time horizon, and appetite for risk, make up the toolkit we use in our daily approach to managing our clients’ investments and the advice we give.

Does this mean we ignore current events? Absolutely not. There are fundamental shifts that occur over time that help guide certain parts of the portfolio. One example of this is how our expectation of future interest rates impact the types of fixed income securities we recommend. During periods when rates are expected to rise (the current view), we strive to stay on the shorter end of the yield curve to lessen the impact of declining bond values while seeking unique areas of the fixed income market with positive correlation to rising rates.

We know last month was challenging for investors. The S&P 500 lost -5.47% of its value during January alone. With that in mind, was it challenging being an investor during 2021 when the same index gained 28.68% (source)? Obviously, no. But as investors, we must take the good with the bad since we rely on our commitments to an investment philosophy to smooth out the short-term noise.

The future is always uncertain. Many potential events are currently shaping the investing landscape. Yesterday’s 7.5% CPI (inflation) reading was a negative surprise, but one that makes sense given the Omicron surge of late December and January. The markets are digesting this number to price in what they believe the reaction from the Federal Reserve will be in March and the remainder of the year. Will the Fed increase rates by 0.25% or 0.50% and how many times this year? Will quantitative easing turn into quantitative tightening? If so, when? Does Russia invade Ukraine? Is there another COVID variant lurking around the corner? These are some of the uncertainties we face right now.

While I don’t know the answers above, I do know that markets are resilient and always forward looking. I know that corporations have an unwavering ability to flex in response to current events with the goal of increasing shareholder value. And I know that the future remains bright, albeit, challenging at times. The one constant lesson that investors know is that conviction matters: “time in the markets is better than timing the markets.” – old adage.

If you’re the type of investor who is seeking a partner to help you through the next few chapters of your life, consider getting in touch with us today. We’d love to learn more about you and how we may be able to team up.

Inflation Surprise, Really?

May 18, 2021 by Justin M. Follmer, MBA, CFP®, AIF®

It’s been a volatile week. For the better part of six months, investors haven’t seen a material pullback like we are seeing right now. Several newsletters ago (available only to clients), I stated “a strong recover is likely, but we can’t rule out a market correction on any potential negative catalysts.” It seems we now have that catalyst in the form of a spike in inflation.

Let’s put this in perspective so we are all on the same page.

Wednesday’s Consumer Price Index (CPI), the widely accepted measure of inflation, came in at 0.8%, the highest in 13 years and was much higher than the 0.2% predicted. This pushed the year-over-year number to 4.2%, much higher than the 2.6% from March’s reading. But we have to take this in context…what was happening in March/April 2020? You guessed it, lockdowns.

Since then, we’ve seen massive amounts of stimulus, a 25% increase in the M2 money supply, a 2×4 piece of lumber almost double in price, housing values significantly higher, and extra unemployment compensation that’s causing a labor shortage and price increases. Are we really surprised by a spike in inflation?

So if it was kind of expected, why are the markets acting like an angry toddler? In my opinion, markets were overextended from the past several months of rallying. Any negative catalyst that could imply the Fed tightening monetary policy sooner than they’ve stated was enough to cause this pullback. Recall the Fed “not even thinking about thinking about raising rates?” Yeh, they may consider “thinking about it” now if next month’s CPI reading runs even hotter. In my opinion (and history is on my side), raising rates gradually, methodically, and transparently is far better for markets than trying to chase higher inflation with drastic increases to control it. The latter typically causes a recession. Being proactive is the key here and I certainly hope Powell & Co. (slang for The Fed) are smarter than me.

Am I allowing this to change my clients’ investment strategies? A resounding, no. These past few weeks have seen an increase in selling on the growth/tech side of the style box and buying on the value side. This has pushed value stocks higher and my clients have benefitted from this. Even during broad market down days, we see the value side perform less-badly than growth. Why are we positioned this way: Our Investment Philosophy.

Should we add inflation hedges?

The best long-term inflation hedge is equity exposure, in my opinion. Even during these short-term bouts of volatility, equities are typically the best bet. Other inflation hedges are Treasury Inflation Protected Securities (TIPS) and ultra-short bonds for conservative clients. Real estate exposure and commodities (gold, oil, raw materials, etc.) are hedges as well. But none of these have the long-term track record that equity exposure provides. Since my clients are globally diversified, most of them own all of these already. I can’t make a case for timing our way into and out of concentrated positions specifically to hedge against inflation. Recall that we aren’t traders, we’re investors.

Higher inflation is a drain on purchasing power. So too are higher taxes. Both of which we are likely facing in the coming year. These questions remain:

How “hot” will inflation run before Fed intervention?
How much will taxes actually increase under President Biden’s proposal?
What other catalysts are we likely to face through the fractured reopening of America and the world?

For clients of Coastal Wealth Advisors, I monitor this information, among many others, daily and keep clients informed of issues relevant to their invested dollars, like inflation surprises. We maintain a passive approach to our investment philosophy, but an active approach to monitoring and rebalancing as needed. Monitoring is the final step of the financial planning and investment management process. It is in this phase of the process where I believe value is created. It’s crucial to be in contact with your advisor often. When’s the last time you heard from your advisory team? If your answer is more than a year, let’s chat. I believe there’s a better investment experience waiting for you. Get in touch here.

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.