Market Pulse: January 2019

PWA Wealth Management publishes a Market Pulse video to help you better understand the decisions we are making on your behalf. Please take a moment to watch January’s edition.
























So as all of us are aware the stock market was booming right through September.  The economy was booming through September and then October happened and it seemed that the world suddenly changed.  Suddenly everyone was concerned about rising interest rates and whether, in fact, the Fed would slow the economy down too much.  People became concerned about what’s happening in China and if our trade policies here in the trade war that is developing would, in fact, further slow the economy in China which would ripple through the entire world.  And so the Stock Market, which always needs a reason to correct, chose those two.  

Now if you go back to September and really understand what was happening, five companies, the FANG stocks, Face Book Amazon Apple Amazon and Google had run significantly in valuations.  Amazon worth a trillion dollars.  Apple worth 1.1 trillion dollars. And the rest of the group at historic high valuation level.  What most people don’t understand is that those companies are present in the NASDAQ and those companies are all present in the S&P; they are the largest companies in the S&P and the largest companies in the NASDAQ and they also have some representation in the Dow.  And so when those companies’ stock prices began to go down a bit it dragged the entire market down with it.  A fairly typical correction unless, of course, you listen to the news. 

So one of the things that most people don’t understand is the fact that those companies are, in fact, the largest companies and the fact that they were present in all of the indices and the fact that every major growth mutual fund on the planet had to own them… As the stock prices corrected they dragged down everything with them.  And so we went through a period where Apple went from being worth a trillion one-hundred billion to something under seven, well seven-fifty would be the number.  Sorry about that.  Apple went from a trillion one-hundred billion to a number less than eight-hundred billion.  Amazon went from a billion….   Amazon went from a trillion to a number under eight-hundred billion.  What you saw in Netflix was a halving in their value.  What you saw in Facebook was approximately a forty-five percent decline in it’s value.  And Google didn’t quite experience the same beat-down but like all of the other members of the FANG community it too declined fairly precipitously.  But what does that mean for you?  Every investor, if they are invested in S&P 500 companies, experienced that decline.  And as those companies came down they brought down the entire market.  And let’s ask another question:  The fact that those companies brought down the market, did anything fundamentally change with those companies?  Let’s leave Facebook to one side because something clearly changed there.   Did anything change with Apple?  Did anything really change with Amazon?  Did anything change with Google or Microsoft?  Did anything change with the leading companies in the world in the technology arena?  I would argue not, with the exception of one thing; their value.  

Well they brought everything down with it and if you are an investor of any kind and you owned large-cap US companies, you experienced it.  

…because it is natural because in terms of what investors experience, the lack of knowledge, the lack of understand is the greatest threat to an investor because the lack of knowledge and the lack of understand is what creates the fear.  It’s very clear:  we sit here every day and try to manage investor portfolios.  Why?  Because we understand their fear.  Ultimately, fear results when people fail to understand clearly if they are going to be able to meet their objectives.  Well what does that mean?  They haven’t defined them properly?  They don’t have a plan that’s clear in their own minds?  And so when markets turn, which is absolutely normal, and fear becomes prevalent, if you knew that you had a clear plan to achieve y our objectives you’d be able to put fear in your back pocket.  But if you didn’t and if you don’t then that’s the level of understanding you need to have so that you can, in fact, put fear in your back pocket.  

Because market downturns are normal; they’re not abnormal.  Markets correct.  Why?  Because they become overvalued and something triggers a corrective process.  There is always a reason that someone will tell you, after it’s happened; not before.  And so if we simply think about what it means to be an investor, it means identifying the goals you are trying to achieve and and building your portfolio in a manner that allows you to get there.  

So one of the things that people fail to understand is when individual names become the dominant names, when Apple and Amazon and Google and Facebook and Microsoft and Netflix become the dominant names and they occupy the dominant role in more than one indices, the S&P and the NASDAQ and with some exposure in the Dow, as those names come down they bring the entire market down with them.  As markets correct fear levels increase; that’s the normal process.  

So when we talk about planning and we talk about weathering the storm, what’s the typical advice that the advisory community gives to the investor?  “Just ride it out.”  “Just ride it out” is terrible advice.  The proper advice is “Plan properly for your future.”  If you know that you have ten-year and twenty-year horizons and that money is, in fact, invested in the stock market, you’re not “riding it out,” you’re simply achieving the objectives over time that you should achieve.   And what happens during those periods of time?  Sometimes the markets go down.  But most of the time they go up.  And so over a ten- or twenty-year period what is the probability that you will achieve better returns that one would experience if they put their money in a can or put it in a CD?  Well history tells you that the probability is very high.  Not a hundred percent.  There are no guarantees in the Stock Market.  But the probabilities over a ten- or twenty-year period are extremely high.  That’s why having a plan allows you to achieve your objectives.  Riding it out may not.  

At PWA Wealth Management one of the things that we chose to do is to create what we call a Goal Policy Statement.  Institutional investors have something they call and Investment Policy Statement and it defines the allocation of the portfolio.  The Goal Policy Statement does precisely the same thing.  How does one build a plan?  By identifying the goals that we are attempting to achieve.  Those goals will either be achievable or not.  We have to define them.  And after we’ve defined them what does that do for us?  It allows us to answer the question, “Can we do it?”  What else does it allow us to do?  To define the risk we need to take to achieve the objective.  And so when  you are building the plan you begin with the goals.  Some are very short-term in nature:  I need to be able to pay my bills each month.  Not just each month for the next few month but each month for the next twenty years.  Some are very long-term in nature:  I want to put money away for twenty years for the grandchild that I don’t yet have so that he or she, when they get to college can have some money set aside and I’d love to help them pay for their schooling.  Some are undefined:  I just want to feel safe.  I want to feel secure.  Because in the end what does money do for us?  It allows us to feel secure.  It allows us to feel comfortable that what?  That we’re OK.  That whatever comes next, we’re OK.  We don’t have to worry about money.  Because when worrying about money the stress level gets way too high and decision-making becomes very erratic.  We want to avoid both of those.  

For the past thirty years I have been helping people and we as an organization have been helping people plan their retirements.  By way of example I’ll tell you about something I never planned for: clients telling me they need twenty- or thirty-thousand dollars for their teeth.  Unusual.  The fist time someone said to me, “Joe, I need a lot of money to fix my teeth.”  Of course I said, “Well, how much is a lot?”  “Thirty-thousand.”  “For What?”  “I’m getting implants.”  Thirty years ago people didn’t get implants.  They do today, pretty routinely.  It’s a new part of the plan.  We didn’t foresee it thirty years ago but it’s become part of people’s lives today.  There are many things in the future that you can’t plan for today that will in fact become part of your life, later.  It happens all the time.  People have health events.  People decide they want to take extended vacations.  People’s children decide to move back into home with them.  Individuals, unfortunately, have to go into other types of living arrangements.  These aren’t always things we planned for.  These are things that life delivers to us and in that process we need to react.  It doesn’t change the fact that understanding where we’re going allows us to get there.  

One of the areas that people don’t fully understand is that you can only spend your after-tax income.  So one of the issues that need to regularly review with clients, and frankly, is part of our normal behavioral process here at Managing Money is to understand what the returns will look like net of taxes and then of course, net of inflation.  Because one of the things that we know will happen over time is that whatever the spending needs happen to be today, they are going to be more, later.  And the other thing that we have seen, and it’s rare, on a temporary basis, 2018, 2019, 2020, we’ve had a lower tax rate than we’ve had in the past.  And as a result we’ve done some sophisticated tax planning across all portfolios to make sure that we take advantage of these lower rates while we have them.  One of the things that we always do for all clients and in all portfolios is recognize that taxes matter and we want to keep them as low as possible.  

So an example of a tax-minimization strategy that was available in 2018 and will also be available in 2019 and 2020, assuming that tax rates don’t change, is using your existing IRA account to do a Roth conversion.  If you have children that are ultimately going to inherit your retirement account and they are in a higher tax bracket than you are today then there is the potential advantage of prepaying the taxes at a lower rate, moving the money out of a traditional IRA so that later, when your children inherit that Roth IRA, they inherit it with no income tax.  Effectively, if taxes would have been paid at thirty or thirty-four or thirty-six or thirty-nine percent but are being paid today at twenty or twenty-two or twenty-four percent you’re gaining a tremendous advantage by prepaying that tax and converting to a Roth.

We’ve probably done a half-dozen to a dozen of them with relatively high-wealth clients.  So somebody that had two-million dollars in an IRA and we maximized the use of the twenty-four percent bracket because their children were already making more money and working so they were already in a higher tax bracket.  Again, if it comes down to you giving the money to charity then don’t do it because you’ll never pay the tax.  But if you’re planning on giving it to humans who are in a higher tax bracket than you are, right?  Do it now.  Pay the tax.  

Well I think that as soon as Democrats get control of the House and the Senate and the White House they will raise taxes.  I mean taxes are as low as they have been since, I don’t want to say “in history” but very very favorable tax rates all the way up to about four-hundred thousand dollars.  

I’d like to spend a few minutes to give you a historical perspective on interest rates.  So if we roll the clock back to 2007, before the Great Recession, in the midst of the housing boom, interest rates were relatively high.  Let’s define relatively high, long-term rates in the six- to seven percent range and short-term rates in the four percent range.  And then what happened?  The world changed.  The Great Recession occurred.   The Stock Market collapsed.  Banks imploded.  And what did the Fed and the Treasury do?  They set about a policy that kept interest rates extraordinarily low.  They forced money into banks so that you could go there and get your money out, therefore avoiding any fear that money would go away; the run on the banks of the Great Depression led us to a decision that was a sensible one during the Great Recession.  And then the Fed decided they would keep rates very low for an extended period of time.  So as all of you know, if you kept your money in a money market fund your rate of return was about one tenth of one percent.  And in some cases zero.  Be happy you are here where you could get zero because if you happened to be in Europe you had to pay to keep your money in the bank. Those are called negative interest rates.  So approximately three years ago the Fed began to realize that they would have to normalize rates.  Except they don’t know what normal means because normal is different all the time.  What they do know is that they need to achieve certain objectives; certain employment objectives, certain inflation objectives and they went about the task of beginning to raise interest rates.  Which rates?  The Fed Funds rate which gets reflected in short-term interest rates.  They don’t have long-term interest rates on their ability to monitor and change.  They can do Quantitative Easing or they can continue to sell bonds which can have some effect on long-term rates.  But the reality is that most of their impact is at the short end of the yield curve.  And so what did they do?  They kept raising short-term rates until December of 2018.  And then the Markets said, “No more!  Don’t do it to us any further!”  And then in January, on the fourth of 2019 Chairman Powell said, “Ok, we’re going to slow down.”  And the market loved that.  Why?  Because the Market fears recession and when long-term rates are lower than short-term rates, that’s called an inverted yield curve.  And when the yield curve is extremely flat, meaning whether you put your money into a one-year bond, a five-year bond or a ten-year bond you’re gaining the same, or nearly the same rate of return that signals some level of anxiety, some level of stress in the marketplace.  Because in the bond market, if things are booming long-term rates would be higher.  But are things booming or not?  Inflation:  in check.  Unemployment:  3.5- 3.6 percent unemployment , by any measure considered full employment and placing stress on the job market in terms of “We need to hire people that we can’t find.  Or, we’re going to have to pay more.”  Wage inflation.  We’re seeing that everywhere in the economy.  We’re seeing companies growing.  Certainly there are examples, Sears, as an example.  General Motors choosing to close a plant, are examples of cutbacks in jobs.  But those people are being absorbed quickly because unemployment is very very low.  General Motors just announced today, exceptional earnings despite the fact that they had to reduce capacity at one of their facilities.  So you understand that interest rates are just a signal; they are a tool.  

And as you see, interest rates in the marketplace changing you simply need to understand that the Fed has its finger on the pulse of the economy.  They are never going to be perfect.  They might raise rates a bit too much or they may not raise them enough.  Over time they will correct to what they believe to be the proper policy.  But they have all the information and they make decisions accordingly.

So let’s go back to what I said a few minutes ago.  We had the Great Recession of 2009.  Terrible low point all over the world, economically.  And then from 2009 to 2018, inclusive, we have been growing.  There has been no recession during that period.  

A few minutes ago I spoke to you about the Great Recession of 2008 and 2009.  And then what happened?  Beginning in 2009 and running all the way to 2018, inclusive, we’ve been in a growth economy.  A fantastic growth economy where profits grew, where earnings grew, where jobs grew, where everything that we would want to measure went up, including the Stock Market.  And so where do we find ourselves today?  We still have exceptionally low unemployment.  We still have a fantastic business environment.  We still have companies building the things that they build.  We have companies selling the things they sell, with one exception.  The one exception is that we have a little more worry today.  And so that little bit more worry today triggers a bit of anxiety and a bit more volatility in the Stock Market.

So the key sources of worry:  Will the Fed tighten interest rates too much?  Will we have an extended trade war with China?  Time will tell.  But here’s what we know:  These issues will be resolved.  What else do we know?  We know that every business on the planet that is doing business every single day recognizes the issues that are right in front of them.  They see what is happening.  Then ask yourself a simple question:  If you’re running Apple, if you’re running Amazon, if you’re running General Motors, if you’re running Merk; pick the company.  What are you doing?  You’re recognizing the problems that you think exist, making necessary decisions inside your business to avoid having any significant downturn in what?  In your earnings.  That’s what business managers and business executives do every day.  

Realizing that business leaders make decisions every single day for the benefit of their business and understanding that the brain trust of the entire world’s leaders, every single day, are working for the benefit of the businesses they are leading is critically important to understand as an investor.  And it’s even more important to understand as an advisor.  Because one of the things that we have to do is to recognize when there is great leadership, trusted leadership and recognize when there is leadership that has gone astray.  When leadership fails we don’t want to be there and those companies we want to avoid.  And that’s the process of understanding what you own.  

Every administration for the last forty years has recognized that we have a trade imbalance with China.  It’s been present for decades.  This administration has decided to take significant action to try to alter that trade imbalance.  It’s called a trade war in the media.  But the reality is that it’s just a means to try to change the trade imbalance  that we have with China, the second-largest economy in the world.  Understanding what a trade imbalance means is simple.  We buy more from them than we sell to them.  They win because we give them more dollars than they give us in their currency.  What does it mean for American businesses to have a trade war?  We’re willing to have the trade war, we’re willing to have the trade imbalance if, in fact, China is willing to level the playing field and to allow American companies to do more business there.  This administration has decided to make a stake in the ground.  They are going to press the Chinese to level the playing field.  How’s it going to work?  Time’s going to tell.  A good friend of mine says, “Joe, you’re an optimist.”  Why?  Because I believe it will, in fact, get resolved in a positive manner.  Why?  Because it has to.  Ultimately the Chinese people and the American people need it to be resolved in a positive manner.  The current administration here and the current administration there recognize that and need it to be resolved in a positive manner.  Therefore the realist in me suggests that it will be.  

…is, as you describe it to me I understand it.  Most other times I simply don’t understand what people are saying to me when we get into trade wars issues and tariff issues and tax-related issues and how markets work and why markets work.  In the end what we’re all trying to do in this uncertain world that we live in, in this world that is constantly changing, we’re trying to make sound decisions that allow us to meet our goals.  It’s really that simple.  

One of the messages that individual and institutional clients routinely give to me is, “Joe, you really help me to understand those things I don’t understand.  You put things into English in a way that it makes sense to me.”  So whether we’re talking about a trade war, a trade deficit, interest rate flattening, yield curve related issues, how economies work, what’s happening in the marketplace.  In the end it simply comes down to the individual understanding what they are trying to achieve, us laying out the goals with them, putting the roadmap in front of them and then working toward that end. 

What is the philosophy of PWA Wealth Management, on the investment side, for helping clients achieve their objectives?  The number one philosophy is that we shouldn’t take any more risk than we need to.  And then it comes down to how do we choose to define risk?  Because our definition of risk is likely different than what the marketplace might typically think.  As an individual investor you think, “It went down today.”  That’s not the risk.  The risk is that you run out of money in fifteen years.  Said another way, failure to build the portfolio properly to achieve the long-term objectives will certainly result in your failure to meet them.  So risk is not what the market does in a day or a week or a month.  Risk is making sure that you truly understand how to put the portfolio together in a way that allows you to get to where you want to go.  And if you’re not willing to accept short-term mood swings in the market, also called corrections, you’ll never be able to achieve the long-term benefits that the markets provide.  Now what are we doing when we are trying to buy an individual stock?  What are we doing when we are deciding where to invest money in the bond market?  We assess everything about the market we’re trying to invest in.  We understand it in detail and then we make decisions based on all of the information we have.  What do we do when the information changes?  We adjust the portfolio.  Why?  Because that’s the right thing to do.  

PWA Wealth Management has been built one client at a time.  Ninety percent of our clients are referred to us.  Our retention rate is exceptionally high. We’re not looking for everyone to be a client.  We’re really looking for those clients that recognize that we’re on their side.  We’re going to work directly and closely with them to achieve their goals.  We work with a limited number of clients and we’d like to invite you to become one of them.   

At PWA Wealth Management we work with a limited number of individual and institutional clients, by choice.  What we have understood since forever is that you can’s serve everybody and if you try to, you’ll do a bad job across the board.  So we’ve narrowed the market to the clients we work with.  We work with individuals, generally, that have more significant portfolios, commonly called “high net-worth individuals.”  We work with institutional clients that recognize that cost matters and that by driving down the cost of investing capital you are much more likely to achieve the outcomes that the markets deliver.  So at all times we’re looking for great opportunities to work with successful clients whether they be individual or institutional and we really would like to invite you to sit down with us to see if we might be of service to you.

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