What does 2018 mean to us…
Part One: General Principles
We neither forecast the economy, nor attempt to time the markets, nor predict which market sectors will “outperform” which others over the next block of time. In a sentence that always bears repeating: We are planners rather than a prognosticators.
Once a client family has a plan in place—and has funded it with what have historically been the most appropriate types of investments—we will hardly ever recommend changing the portfolio so long as your long-term goals haven’t changed. As a general statement, we have found that the more often investors change their portfolios (in response to the market fears or fads of the moment), the worse their long-term results.
In sum, our essential principles of portfolio management are fourfold.
- (1) The performance of a portfolio relative to a benchmark is largely irrelevant to long-term financial success.
- (2) The only benchmark we should care about is the one that indicates whether you are on track to accomplish your financial goals.
- (3) Risk should be measured as the probability that you won’t achieve your goals.
- (4) Investing should have the exclusive objective of minimizing that risk.
Part Two: Current Observations
2018 was perhaps the strangest year we have experienced in our careers as financial advisors. Most importantly, it was one of the truly great years in the history of the American economy, and by far the best one since the global financial crisis of 10 years past. Paradoxically, it was also a year in which the equity market could not get out of its own way.
It is almost impossible to cite all the major metrics of the economy which blazed ahead in 2018. Worker productivity, which is the long-run key to economic growth and a higher standard of living, surged. Wage growth accelerated in response to a rapidly falling unemployment rate. Household net worth rose above $100 trillion for the first time, yet household debt relative to net worth remained historically low. Finally—and to me this sums up the entire remarkable year—for the first time in American history, the number of open job listings exceeded the number of people seeking employment.
Earnings of the S&P 500 companies, paced by robust GDP growth and significant corporate tax reform, leaped upward by more than 20%. Cash dividends set a new record; indeed total cash returned to shareholders from dividends and share repurchases since the trough of the Great Panic reached $7 trillion.
But the equity market had other things on its mind. Having gone straight up without a correction throughout 2017, the S&P 500 came roaring into 2018 at 2,674—probably somewhat ahead of itself, as it seemed to be discounting the entire future effect of corporate tax cuts in one gulp. There ensued in February a 10% correction, followed by several months of consolidation. The advance resumed as summer waned, with the Index reaching a new all-time high of 2,931 in late September. It then gave way to a second correction.
The major economic and market imponderable as the year turns is trade policy, which in the larger sense is an inquiry into the mind of President Trump. It is fair to say, as the economist Scott Grannis recently did, that “Trump has managed to reduce tax and regulatory burdens in impressive fashion, but his tweets and his tariff threats have created unnecessary distractions and unfortunate uncertainties, not to mention higher prices for an array of imported consumer goods.”
These and other uncertainties—perhaps chief among them Fed policy and an aging expansion—were weighing heavily on investor psychology as the year drew to a close. For whatever it may be worth, our experience has been that negative investor sentiment—and the resulting equity price weakness—have usually presented the patient, disciplined long-term investor with enhanced opportunity. As the wise and witty Sage of Omaha wrote in his 1994 shareholder letter, “Fear is the foe of the faddist, but the friend of the fundamentalist.”
Part Three: Looking Forward
What is good about all of this?
Interest rates and mortgage rates remain relatively low, with energy prices trending down. All of these are good, both for businesses and consumers.
Volatility can be hard to experience, but it indicates a normal, functioning market. It also correlates strongly with expected returns. Where there is no volatility, there is also no return (consider a bank account). A carefully measured amount should be embraced.
What can you be doing?
First, keep your faith in the future. We urge you to read the 2018 Market Review as an antidote to any messages you may have heard or will hear in the months ahead.
Second, maintain your proactive behavior and discipline.
- If you’ve committed to a saving plan, or to an IRA funding plan, keep at it. If not, now is the time to begin. Lower stock prices are good entry points; as the broad market falls, value rises. We don’t know when this decline (read: sale) will end, only that it WILL end.
- If you’ve committed to a withdrawal plan, know that your portfolio is managed to reliably provide income regardless of market conditions. Most portfolios have nearly one decade of reserves before an extended market event would suggest consideration.
Without committing additional funds, you may still benefit from lower asset prices by converting some or all of an IRA to a Roth IRA. This action pays the government’s inevitable tax bill at a time when asset prices are lower, and so therefore is the tax bill. Furthermore, federal income tax brackets are historically low. Action guarantees a known tax rate today against an unknown future tax rate.
What are we doing?
Even if you do not act on the items previously mentioned, we are considering them for you. It helps us greatly in this regard to see your most current tax return and for you to promptly notify us if your income is expected to markedly rise or fall as compared to previous years.
In addition, we’ve spent much of the last few months capturing the opportunities this period presented. By harvesting available positions within taxable accounts we’ve created what amounts to a “coupon” against future tax liabilities to offset future gains and potentially, earned income.
Current volatility has also allowed us to rebalance most accounts in a classic exercise of buying low to sell high. Amongst the assets classes, and overall, we have largely been able to do so without triggering a tax bill. Even without the addition of new funds, the purpose-built stability of the income/bond side of your portfolio allowed the reinvestment of dividends, interest, and capital gains at lower entry points. This was a fleeting opportunity created by lower asset prices.
Through this period, we have been net buyers of the greatest businesses in the US and the World. Tomorrow may show this timing premature. Yet, we accept this uncertainty in the shorter-term in exchange for more certainty over time.
Where do we go from here?
Going forward, the only question that matters is the one we guard against the most: Will you outlive your money? If this concern resonates with you, our approach has been designed to minimize that risk.
If you are confident that you have enough, then the only question that matters is: Are you making the best and most intentional decisions to live your life as rewarding and as richly as possible? This is a much more difficult and involved answer. Working towards these answers with you is one of the main reasons we look forward to coming in each day.
We’re sure to have forgotten something or created other questions for you in this message. That’s okay for now; this is all a process and an ongoing conversation. Some questions are easily answered by email or phone, but some are not and require a discussion of options, research, or a face-to-face conversation. Everyone’s situation is a little different.
Please, let us know what is on your mind.