2018 Q1 Letter to Clients

Dear Clients,

We know spring is in full swing when the days grow longer and warmer. We also recognize that this is tax season, as the calls from CPA’s, tax professionals, and come at a fast clip. The volatility of the first quarter of 2018 was quite a shock relative to the experience in 2017. We are pleased to share with you below some of our thoughts on the causes of this turbulence, as well as putting it into the context of your portfolio.

First Quarter 2018 in Review

Coming off the back of a euphoric 2017, financial markets experienced a bit of a roller coaster ride in the first quarter of 2018, with the S&P 500 declining 1% for the quarter. Although the decline for the quarter was relatively benign, the intra quarter swings were dramatic – the index was up as much as 7.5% in January, and down as much as 3.3% in early February. The 10% mid quarter swing from January to February is often referred to as a “correction”. The remainder of the quarter exhibited similar swings with no clear direction through the end of March.

The fixed income market fared slightly worse than equity markets, declining by 1.5%. We have seen short term interest rates continue to rise, and a flattening of the yield curve is well under way. We think that there are several factors at play that will continue to drive interest rates up. Most importantly, the Federal Reserve has publicly committed to raising interest rates throughout the year, perhaps more aggressively than originally anticipated. In addition, unemployment remains near all-time lows. On top of that, uncertainty and volatility in the equity markets has driven more investor money into bond markets. We believe that higher rates will, all things considered, be better for savers and our clients in the long run. However, a rising rate environment can be challenging for current investors in the bond market, and we intend to stay diligent as rates continue to seek a new equilibrium.

Internationally, markets were similarly challenged. The MSCI EAFE (a broad index of non-US stocks) declined 4.3%, emerging markets rose 1% and were the only major asset class to see a gain, while the Nikkei (an index of the stock market in Japan) declined 6%.

Market Commentary

It is worth noting that this quarter’s decline in the S&P 500 represents the first negative three-month period return since the third quarter of 2015. We believe that many investors have been lulled into a sense of complacency by this period of two and a half years of steady market gains, making the volatility of this most recent quarter even more jarring to some.

As we have discussed at length in prior letters, we continue to be concerned about market valuations. As the chart below highlights, even with recent volatility, markets are at their most expensive point in 10 years, as measured by PBV (Price to Book Value) and PE (Price to Earnings). We recognize that markets, in the absence of a catalyst for reverting to the mean, can remain expensive for extended periods of time, and so we remain diligent in keeping an eye on these measures.

 

An additional contributor to uncertainty is the seeming conflict between monetary and fiscal policy. Monetary policy (managed by the Federal Reserve) is currently focused on tightening the money supply to constrain growth (i.e. raising interest rates), while fiscal policy (managed by congress) has taken accommodative actions in the form of lower taxes. While the Fed has stated their intention to continue raising rates in 2018, we think that it will be interesting to see if the Fed is able to stay the course while keeping a close eye on inflation targets.

These bullet points are an evidenced-based way of saying turbulence surfaces from time to time. Patient investors who do not react emotionally have historically been rewarded.

The volatility we saw this quarter is, to some degree, a reflection of uncertainty. We provided an explanation for the recent volatility because we believe one is in order, but let us caution you not to get lost in the weeds. Day traders care about minute-by-minute swings in stocks prices. Long-term investors sidestep such concerns.

To give you some perspective of the larger context in which we, as long-term investors, view volatility let us step back and review a few data points about volatility:

  • The average intra-year pullback (peak to trough) for the S&P 500 Index since 1980 has been 13.7%.
  • Half of all years had a correction of at least 10%.
  • Thirteen of the 19 years that experienced an official correction (10% or more) finished higher on the year.
  • The average total return for the S&P 500 during a year with a correction was 7.2%.

These bullet points are an evidenced-based way of saying turbulence surfaces from time to time. Patient investors who do not react emotionally have historically been rewarded.

Trade and Tariffs

The last, but most impactful contributor to volatility this quarter, was the issue of trade and tariffs. This past quarter President Trump proposed tariff increases on some of the largest US trading partners. While initially thought to be a sweeping action affecting all global trading partners, the administration has since focused on China, suggesting tariffs on $60 billion of imports. Markets roiled towards the end of March as the rhetoric intensified.

To understand the implications of tariffs, it is important to understand what tariffs are. Tariffs are taxes on goods from other countries, and they can be implemented for a handful of reasons: 1) to make money for the government 2) to protect domestic industries from competition, and 3) to punish companies, countries, or industries that are thought to be unfairly advantaged or cheating in some way (dumping, stealing intellectual property, uncompetitive subsidies, etc.).

It should come as no surprise that we, as a country, buy A LOT of goods and services from China. In fact, the US collectively spends significantly more money buying things from China than they spend buying from the US, leading to significant trade imbalance. In 2017 we imported over $500 billion in goods from China, while we sent them just over $100 billion in exchange.

China has often been accused of manipulating its currency, stealing intellectual property from US companies, and dumping inexpensive products onto the market. This makes it difficult for US companies to remain competitive. The President’s proposal addresses some of these issues head on. In response, China came back with some in kind tariffs (only $3 billion as of the writing of this letter) as an indication that a compromise should be reached before the situation escalated. The problem is that, without diplomacy and an attempt to negotiate, a trade war can ensue that would disrupt markets further. Negotiated and fair trade ensures global commerce can grow in a healthy manner. Conversely, a protectionist strategy may instigate a trade war, can be destructive to innovation, and ultimately weaken an industry by raising prices and inhibiting growth. We believe it is unlikely that a trade war will ensue, and that cooler heads will eventually prevail. In the interim, the bluster and rhetoric can be distracting and disruptive to markets.

Summary

The media was rife with sensational headlines this quarter. While it is true that markets experienced a bit of a roller coaster ride this quarter, the difference between the begin and end points was nominal. It is our belief that some investors have become so distracted by markets that only go up, that they have forgotten that risk and volatility are part of normal markets.

In 2017, market volatility was lower than at almost any time in history, with a standard deviation measurement of just 6.7% on the S&P 500. By comparison, over long periods of time, equity market volatility has been about 12%. In stark contrast to both of those numbers, S&P 500 volatility increased to 20% (on an annualized basis) in the first quarter. It is undoubtedly fun and devoid of stress to watch markets rise and the economy to continue moving forward. However, the reason that we, as investors, are rewarded for allocating our dollars to a particular investment is that there is risk involved. A market with reward, but no risk, is not a healthy market. While risk, as measured by volatility, may have taken a break in 2017, we believe that it always comes back and has done so in a big way in the first quarter of 2018.

At Silicon Valley Wealth Advisors, we strive to look past the current moment with our investment strategy. Our goal is portfolio growth, and helping our clients achieve their financial goals, while also acting to safeguard client portfolios. We focus on the horizon to minimize volatility and stay aligned with our client’s goals.

As always, we appreciate your confidence and welcome your questions.

Gratefully yours,

The Silicon Valley Wealth Advisors Team

Tracy Lasecke, CFP®
Chris Duke, CFP®                        
Scott Yang, CFP®, CPA
Heidi Graham
Adam Gelhausen
Robert Lopez
Alison Lee
James Karel


What We’ve Been Up To

Tracy and Roberta and were able to make a couple of trips to Arizona to visit clients, friends, and family. They managed to attend 3 Giants spring training games. If spring training games are any indicator, they felt the Giants were much improved over last year. The prior spring was an unfortunate look into what would turn out to be one of the worst seasons in Giants history. They are hopeful that this spring’s promise holds true.

Chris and his family were blessed to be able to spend time with friends and to get in a couple of days of skiing and snowboarding this winter. The snow conditions in Tahoe were a bit sparse, but we made the most of it. Sawyer really took to skiing, to the point that Chris can barely keep up with him as he streaks down the hill. Siena decided she wanted to take up snowboarding, which was a lot of fun for Chris (who is one of the few snowboarders in a large circle of skiing friends). Laura has had some injuries the past few years, and really enjoyed getting back into the swing of things this year.

Scott and the family had a pretty quiet pre- spring quarter, focusing on watching the kids play on their high school basketball teams.

Adam visited some friends on Kauai island in Hawaii. It was good to get away and spend some time enjoying good company and cooking some great food. Despite the persistent rain there were a couple days of sun but no matter, the hikes and landscapes were that much lusher. Climbing down into Wailua Falls was made even more challenging due to the mud, but well worth it at the bottom.

Ali and Guy are eagerly anticipating the arrival of their daughter at the end of May. Ali is looking forward to maternity leave, and is eager to get their new basement apartment all settled. The nesting urge is strong and there are lots of gifts to sort through after their massive Alice in Wonderland Mad Hatter Tea Party thrown by Ali’s Family. As new parent’s, Ali and Guy are trying to figure out what else they need to prepare, from birthing plans to diving into the world of cloth diapering.

Robert has spent much of the past few months studying for the Certified Financial Planner (CFP®) Exam. We are happy to report that he passed his exam and will soon qualify for the CFP designation. Robert and Shirley are also looking forward to their upcoming trip to Europe to celebrate their Anniversary.

Jim enjoyed numerous experiences on the Homefront. His son James did an internship, and ably gave insights on Bitcoin and underlying “blockchain” technology. His daughter Sophia continues to negotiate for global travel with dad to visit eastern bloc countries, as well as China. Katherine, with a newly minted driving permit, has everyone’s full attention!



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