As football and hockey take the main stage we must tip our hats and offer congratulations to the boys of summer. The Giants entertained, and the A's almost pulled it off. We are pleased to report our thoughts on the market below.
Third Quarter 2018 in Review
US markets climbed to unprecedented levels once again this quarter. Most US equity indices reached all-time highs with the S&P 500 increasing 8.5%. Despite the foreshadowing predictions of a global trade war, US companies have shown strength in earnings and investor enthusiasm has not waned. This is in stark contrast to international markets which have shown relatively anemic returns for the year and quarter. For the third quarter, the MSCI EAFE returned 2.9% This bifurcation in global markets highlights the strength of a comprehensive asset allocation portfolio to insulate against lagging markets while benefitting in others.
More broadly, global markets continue to be driven by the daily vacillations surrounding the subject of trade. We have all been witness to the daily headlines over the last six months where new tariffs or retaliatory tariffs have been instituted. The US administration is committed to managing trade by levying taxes on other countries to place them on an equal footing competitively with domestic producers. So far, the consequence of these actions appears to be in our country's favor, as GDP has increased, the labor force is at full employment, and the stock market is rising. This contrasts with international markets which are seeing weakness, especially in China and other emerging economies where markets are largely down for the year. Exacerbating the issue is that the dollar has strengthened as interest rates have risen, and more money is flowing out of foreign economies and into the US.
Trade wars, currency fluctuation, domestic vs. international, interest rates - all these issues are complex and made even more difficult as they seem to be converging into one homogeneous daily headline.
Gains have largely been achieved through narrow segments of the market in 2018. As mega cap companies have gotten larger, so has their impact on market returns. For instance, technology and consumer sectors are winners this year due to names like Apple and Amazon, respectively. This quarter, Apple and Amazon both became trillion-dollar market cap companies, the first in history. These two companies are so large, they constitute 8% of the entire S&P 500 index, almost a 1/10th of an index with 505 companies in it. To put that in perspective, these two companies are responsible for 40% of the S&P 500's 10% return this year. This level of concentration is staggering, and we would caution that while it feels good going up, it will impact negative returns the same way in a decline.
This growth has not only come with successive increases, but also has shown that value investing, a historical bellwether and successful long-term investing strategy, has been eclipsed by growth investing. These two strategies are defined by their valuation approaches, often condensed to simply an evaluation of price-to-earnings ("P/E") ratios, respectively.This year alone, growth stocks have outpaced value by almost 6x.
As highlighted below, since 2008 growth investing has been the winning strategy. Even more illustrative of this is that growth companies have experienced only a few anomalous periods of earnings volatility, which is in stark contrast to value companies which can show far more cyclicality.
The conclusions that we make on this subject are threefold: 1) We believe market growth will waiver in the next 12 months. Markets are driven by expectations and given the current momentum, the likelihood for disappointment is increasing, 2) Value will have its day again. It may seem like things have changed forever, but history has repeatedly proven otherwise, and 3) Relying on a narrow investment strategy will work for a period of time but a broader approach will insulate against extreme volatility that concentrated strategies can possess.
From the depths of the recession to present day, international markets have lagged US markets consistently. From a valuation standpoint they appear cheaper, offer higher yields, and possess lower interest rates than US markets. But that value proposition has not compelled investors. The reason for this under-performance varies from region-to-region, but the difference remains nonetheless.
As the chart above shows, except for a brief period in 2009, P/E ratios have increasingly diverged between S&P 500 and the MSCI EAFE (the MSCI EAFE is a broad index of equities in developed markets, excluding of the US).
Despite a similar monetary policy of low interest rates, Europe never experienced a resurgence in GDP growth. In addition, the EU remains mired down in the complexities of BREXIT which has stalled any kind of economic growth due to the confusion about what exiting the EU means for companies and its citizens.
In Asia, particularly in China, the advent of a growing trade war with the US has sent the market in a sharp decline. The Shanghai Composite declined 14.7% during the quarter on fears of slowing exports.
The short-term implications to President Trump's trade decisions have been favorable to US markets. The long-term effects are still unknown, but these decisions have made relationships with respect to US exporters more challenging, risk that other countries will increasingly ally against the administration's actions, that could create longer term problems.
The added magnification to international returns is currency. The dollar has been steadily rising as rate increases have been implemented. Money flows to different global currencies is driven by higher yields, and when the US is paying a premium relative to others people buy dollars and sell foreign currency, which pushes the value higher. As the table below shows, we are far and away at higher levels.
The Federal Reserve has maintained a commitment to a steady pace of rate increases since 2015. This quarter, the Federal Fund's rate was increased for eighth successive time by 0.25% to a level between 2.0% - 2.25%. The Fed has indicated they intend to move rates higher one more time in 2018. Longer term, we expect rate hikes to continue but a more modest pace. We expect two additional 0.25% increases in 2019 if inflation remains in check. If inflation accelerates too aggressively, we could see even more rate hikes.
It is clear the US markets are staying in step with the US economy. The added fuel from legislative tax cuts in 2017 have driven GDP growth above expected levels. We expect this trend to continue for at least another year. That said, the potential for eventual market declines is getting larger and we are keeping an eye on the horizon to ensure that our allocations reflect this risk potential, and we maintain exposure to other markets that command higher yields and greater long-term upside when markets change.
As always, we appreciate your confidence and welcome your questions.
The Silicon Valley Wealth Advisors Team
Tracy Lasecke, CFP®
Chris Duke, CFP®
Scott Yang, CPA, CFP®
Raechel Cline, MBA
Happenings @ SVWA
As usual, we have been very busy working in the background to improve the capabilities of the firm, to always be on the lookout for the best investment research platforms, and to leverage the best technology available to us, all with the ultimate goal of improving the level of service we provide you. Some highlights below:
- We have enhanced our relationship with FactSet, which is seen by most professionals as the preeminent research and analytics firm for market data.
- We are in process of switching our portfolio reporting tool from Tamarac to Orion. The is a long and tedious process, but we think it will eventually give you a better and more reliable reporting experience and will allow us to improve our analytics.
- We recently partnered with a 529 platform provider called com to help our client manage 529 accounts. We have struggled for some time to find a 529 platform that had a good investment lineup at a reasonable cost, and that integrated with our existing systems. We are actively migrating clients with existing 529 accounts over to the new platform (via tax deferred transfers). Some of you have 529 accounts that we do not know about, so let us know if we should talk to you about this!
- After an audit by the SEC, one of the recommendations that we received was that we shift our data storage from local in-house servers to the cloud. We have complied with their suggestion and have nearly completed that transition. Cloud storage provides more robust data backup, data encryption, cyber security testing, and overall better identity protection than in house servers. Practicing what we preach, we use 2FA (two factor authentication) on all of our cloud based systems.
- Continuing the cloud theme, earlier this year we shifted our CRM (Customer Relationship Management) to Salesforce, the preeminent CRM provider today. We believe this will allow us to leverage the many data integration points to continue to improve our client service.
- We are very pleased to have Ali back from leave. She resumes her normal activities on a part time basis.
- We added a new member of the team this quarter. Monique "Mo" Ruiz joined us as Operations Manager. Monique's experience providing excellent client centric care is paying dividends daily.
- Robert Lopez has moved back to Arizona, where his wife (who is a licensed psychologist) got offered a position she could not turn down. We will miss Robert greatly and wish he and Shirley all the best. We have been searching diligently for his replacement and hope to fill the position soon.
Personal Notes @ SVWA
Tracy and Roberta pulled off a road/house boat trip in September. They drove to Death Valley then to Las Vegas and on to Lake Powell for a house boat trip with daughter Jamie and son-law Matt. The adventure was great and provided a nice digital disconnect for all. Lake Powell is an excellent spot for watersports. Shows in Vegas included Jennifer Lopez, Beatles "Love" presented by Cirque du Solei and Donny and Marie!
Chris: It feels like summer came and went in a flash! Perhaps that is because summer always involves a dizzying array of camps, play dates, sleep overs, weekend getaways, etc. Chris did manage to knock off a "bucket list" item by completing a century bike (100 miles) ride around Lake Tahoe. It was an incredible experience! Now, with the kids back in school, Chris and Laura are looking forward to getting back on a regular schedule through the end of the year!
Adam and the kids embarked on a road trip in the final days of summer vacation. They drove along the Oregon Coast and finished in Monterey after almost one week on the road. Highlights included several beaches and stunning vistas, the Evergreen Aviation Museum in McMinnville, OR (home of the Spruce Goose!), the West Coast Game Park in Bandon, OR where they were able to pet a newborn lion, the Big Tree in the Redwoods off of the Newton Drury Scenic Parkway and finishing at the Monterey Aquarium!
Scott and his family had a wonderful time in Lake Tahoe in August. They went on a bike ride, river rafted on the Truckee River, and had a barbeque on the beach, witnessing a beautiful sunset. It was a nice getaway before the start of a new school year.
Monique: I am enjoying my decision in joining Silicon Valley Wealth Advisors several weeks ago. My family and I are finally in the swing of the 2018 - 2019 school year.Her eldest son entered his third year at Gonzaga University in Spokane, WA while her middle son stared his junior year at Lincoln High School. Her youngest son started at his freshman year at Bellarmine College Preparatory and her daughter will turn 2 in this month! We are always together for the Holidays, so I know we are looking forward to taking family photos in December!
Ali: Ali and Guy couldn't be happier with baby Penelope. 4 months old now and she is starting to laugh and really show her personality. Starting back to work what feels like a revolving door of colds and flus, the new family is loving every minute of this new chapter of their lives.
Raechel: The end of summer was a busy one celebrating birthdays, enjoying mini-family vacations, and enjoying as much time as possible with friends and family. Though the long summer days will be missed, the fall brings exciting beginnings: Raechel's son began his first year at a Montessori school in late September and will begin toddler soccer this month.
Jim rejoiced in having kids home from college during the summer.Lake time was limited as the fires plaguing CA were no less in WA, so there were lots of indoor activities at home and at the gym. I am looking forward to Fall, back-to-school preparations, and wonderful weather as New England colors present themselves in Spokane.
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