2018 Q4 Letter to Clients

Dear Clients,

Happy New Year! Family gatherings have come to a close, and binge-watching of Sopranos, Game of Thrones, or Everybody Loves Raymond have supplanted the desire to have just one more holiday treat.

As we have mentioned in prior letters we have upgraded to a new portfolio reporting and management tool. Enclosed is your first iteration of the new report. In short, it has a way to go before we can deliver everything to which we aspire. The first iteration of the report is shorter and less robust than we had hoped. Rest assured that the mission is not complete, and we expect improvements with each passing day. The data contained in your report is accurate but lacks detail. We appreciate your patience with this process and welcome feedback.

Please find our commentary and your report in the following pages.

Fourth Quarter 2018 in Review

Inevitably, the bull market that persisted for so many years following the decline of the Great Recession of 2008, appears to have ended in the last quarter of the year. If the year itself could be summed up in a word it would be "chaos". Everywhere around the world uncertainty and disruption occurred. Despite a strong US economic environment, the weight of global trade, rising interest rates, and constant political discourse finally gave way to uncertainty surrounding growth. The strong performance of the S&P 500 exhibited through the end of the third quarter plummeted rapidly, declining -14.0% for the fourth quarter and -4.4% for the year, respectively. Internationally, markets did not fare any better with the MSCI EAFE declining -12.2% and -10.5% for the quarter and year respectively.

As with all major market fluctuations, assigning a singular issue or catalyst is not only impossible but a fool's errand. What is certain is that these movements are always driven by a change in expectations. In this case, whether macro or fundamental related, investors are concerned that growth is decelerating. After a strong 22% surge in earnings for US companies this year as a result of the tax legislation in 2017 (8% organic), earnings growth will be harder to come by. Estimates for 2019 peaked in September and have been reduced steadily since then.

Perhaps no greater indicator of challenged growth is the US Treasury yield curve. Normally, a yield curve increases over time. Meaning, the longer you hold the investment until maturity, the higher the interest rate it pays. Illustrated below, for the first time in many years, the yield curve is now inverted. This means that interest rates in the nearer term pay a higher rate of interest than long term, in this case the 1-year rate, paying 2.5% is higher than the 3-year rate of 2.4%. What this signifies is that investors expect growth to decline over the next few years, valuing nearer term treasuries a safer bet.

Source: FactSet

As previously mentioned, several factors are weighing down the macro economic outlook globally. The growing trade tensions between the US and other countries, especially China, have persisted. This week, Apple revised its outlook downward, citing sales growth in China as the principal problem. China's economy has continued to deteriorate in the wake of trade tensions - housing, automotive, and consumer spending have all been affected. In 2018 the Shanghai Composite declined almost 20%.

BREXIT remains an issue to not only the European economy but to global economy at large. Britain is slated to leave the European Union in less than three months, on May 29 as mandated by law. But Theresa May's ebbing support of the referendum has given way to a multitude of potential outcomes when the vote occurs next week. If the law is upheld, then the exit will occur as planned. If not, a myriad of options exists ranging from delay to cancellation. This uncertainty is challenging across the board - European citizens, businesses owners, politicians, and financial institutions rely on the ability to plan. Until certainty is obtained, volatility will persist.

Adding fuel to the fire, the Federal Reserve has pursued a steady, yet consistent path to higher rates. Rates increased once again in December by 0.25%. Chairman Powell has indicated that the Fed is committed to raising rates to "healthy" levels, but with confidence in growth slipping, we may see fewer raises in 2019 than previously anticipated. A lengthy stalemate over the protracted government shutdown could hamper growth in the first quarter.

Surprisingly, and perhaps due to the several issues stealing headlines in the global economy, the US House of Representatives reconvened this week and with new democratic leadership, is not showing any signs of acquiescing to the President's border funding requests.

Adding all of this together creates a mosaic of chaos which often translates into volatility, and the last several months has been no exception. Keep in mind that what makes this volatility seem excessive now is that it has been very low for some time. Consider the example of the S&P 500 Index moving plus/minus 1% in a single trading day. In 2017, this happened 8 times; in 2018, it happened a staggering 54 times! So, it may seem like the markets have changed,but in reality, they are simply reverting back to their historical movements. The important point is to remain focused on the long term. Consider that since 1950 (i.e., 1950-2018), the S&P 500 index has been up 54% of 17,361 trading days, 60% of 828 months, 66% of 276 quarters and 72% of 69 years. These numbers should bolster your conviction that the economy will continue to expand over time and this will benefit a balanced portfolio approach.

How we are managing amongst the chaos

We made several changes to client portfolios ahead of the holidays - opting for a bit of conservatism until some of these issues subsided. We exited most of our international positions and opted to purchase non-volatile Treasuries, yielding almost 3%. Ultimately, this has been the right call for now, but we also think that the current market environment may present some buying opportunities this year.

Like a pendulum on a clock, market volatility can create events that benefit client portfolios in the long run. We believe this bout of uncertainty can bring these opportunities in a well-diversified portfolio and we look forward to sharing these with you in 2019.

Summary

As always, we intend to stick to our knitting through these market cycles, relying on a process that has worked throughout our 28-year history. An asset allocation approach has been proven time and time again to be a consistent way to invest on a risk-adjusted basis. Our focus relies first and foremost on capital preservation followed by growth in capital through this strategy.

In these tumultuous markets we remind ourselves and our clients that volatility is part of this business. Recession happen, and we grow out of them, and patience is often rewarded. These market cycles come and go but the world economy will continue to grow, and your portfolio will benefit from this.

Charitable Giving

All of us at SVWA want to THANK YOU for your generous gifting to charity in 2018. Together we contributed over $25,000 to various charitable organizations. Many of you have contributed enormous amounts of appreciated assets to Donor Advised Funds (DAF), which added much capital to those in need. If you would like to discuss efficient ways to be even more philanthropic, please let us know.

A Note about Schwab Trusted Contacts

Schwab has recently started to make a big push for clients to add a "Trusted Contact" to their accounts. So, what exactly is a Trusted Contact? First, please know that adding a Trusted Contact is entirely optional. A Trusted Contact is primarily meant to safeguard you, the client, and will be used in the event that Schwab is not able to contact you and suspects that there has been abnormal activity in your account, or in the case where Schwab suspects financial fraud or elder abuse. A Trusted Contact will NOT be able to see accounts online, be privy to account balances,transaction details, details about your or your accounts, or be allowed to execute transactions. A trusted Contact DOES NOT replace the need for properly designating beneficiaries on your accounts and does not replace proper estate planning.

If you would like to discuss the Trusted Contact further, or would like to update your Trusted contact, please let us know.

When to Expect Your 1099

If you have a taxable account, you will likely receive a Consolidated 1099 form to file with your tax return. If you took a distribution from a retirement account, you will receive a 1099R form.

All Custodians (Schwab, TD Ameritrade) generate these documents in waves - the simplest and most straightforward accounts first, followed by the more complex accounts in subsequent waves (where complexity is based primarily on what assets are held in the account, and when data gets reported to the custodian by the mutual fund, ETF providers, and other investment vehicle providers). Keep in mind that last year a very small subset of 1099's did not get released until the first week of April.

Schwab - the first wave is expected to be released February 1, 2019.

TD Ameritrade - the first wave is expected to be released February 15, 2019.

Another Data Breach in the News / By Federal Law A Credit Freeze Is Now Free

In November 2018 Marriot Hotels announced a data breach of customer data. When discovered, the breach had been ongoing for approximately 4 years. Initial estimates were that hackers had accessed 500 million customer records, which was later revised downwards towards 300 million. Even at the lower end of this estimate, 300 million is the largest known breach to date (Equifax affected approximately 145 million people). The hackers were able to access names, addresses, phone numbers, email addresses, dates of birth, and gender.What makes this hack unique is that passport information was accessed for some customers. Marriot initially reported that some of the data was encrypted, but later revealed that this was NOT the case.

We first wrote a note to clients in November 2017, following the Equifax breach, about freezing your Credit Bureau data. At that time, at least one credit reporting bureau charged a monthly fee to perform a credit freeze, dissuading some from doing so. Due to the outrage caused by the Equifax breach, Congress passed a law in May 2018 (now fully in effect) that credit bureaus cannot charge a fee to freeze a credit file. If you didn't act in in late 2017, we implore you to consider doing so at this time.

Happenings @ SVWA

Below are some of the goings on at SVWA:

• Quarterly Reports: As mentioned earlier in this newsletter, we are in the process of updating our performance reporting tool. While we are very excited about the capabilities of the new tool, the process of implementing, like any complicated software application, can be bumpy. We expect to iterate and improve the report you receive each quarter from here on out, eventually giving you a better and more reliable reporting experience.
• Alison Lee: After 7 years working with Chris, and 2 years working with SVWA, Ali has made the difficult decision to leave the working world and apply all of her time and talents to be a full time mom. The office won't be quite the same without her.
• Monique has already started to make big strides as our Operations Manager. She continues to fine tune operations, implement new business processes, and generally aspires to make your experience a better one.
• Electronic Signatures (eSign): We have started using electronic signatures in a big way. We find that they provide you with much quicker turn around and enjoy faster processing times at both TD Ameritrade and Schwab. Both TD Ameritrade and Schwab use a customized version of the commercial product DocuSign as the underlying provider of this technology. If you are uncomfortable with electronic signatures, please let us know and we will make a note not to utilize them with you. It is worth noting that not all documents are eligible for eSign - there are still times when we will still need to get "wet ink" signatures from you.
• 529 Accounts: As noted in last quarters newsletter, 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!

Personal Notes @ SVWA

Tracy and Roberta enjoyed Thanksgiving with family and friends in Arizona, as well as music and food in Nashville before landing in Park City Utah to spend Christmas with the kids.

Chris and Laura, as well as extended family (parents, sister, nieces, nephews), spent a week together over the holidays in a large rented house in Monterey. We went on a fishing outing, enjoyed the aquarium, perused tidal pools, took long walks along the ocean, caught a few sunsets, and generally ate way too much!

Adam surprised the family during the holidays with a post-Christmas trip to San Diego. Escaping the Inland Northwest to sunnier skies and beaches was a welcome respite from the winter temperatures. The kids enjoyed the San Diego Zoo and a day trip to Universal Studios not to mention several days on Coronado Island.

Scott and his family stayed local for the holidays, as the kids had high school basketball games. Hoping to see some rain in 2019!

Monique: Sushi for Thanksgiving and cookies of every kind for the Holidays! My Holiday was filled with family, love, and baking! As with many households, baking is a big part of our seasonal tradition and this year was no exception. Too many cookies, so many flavors, the calories are nothing when compared to the warmth it brings in our home. Now I am ready for work, bread, soup and the New Year!

Raechel: Happy New Year! I hope you and your loved ones enjoyed a wonderful holiday season. The last few months have been busy with travel for me - spending some time in Seattle and San Diego and visiting family in Montana. I recently joined a new gym and a book club, both of which I'm really enjoying. It's been fun getting to know more people and reading books I probably wouldn't read on my own.

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

Gratefully yours,

The Silicon Valley Wealth Advisors Team

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