First Quarter Newsletter
Responsible Guidance: First Quarter 2019 Newsletter, April 2019
Quite a Turnaround
Capital markets experienced quite a turnaround in the first quarter of 2019, after a dismal 2018 fourth quarter, which included one of the worst Decembers on record for investors. The emotion(s) you felt while markets were going down and then rebounding are part of the process of identifying an appropriate investment strategy for you. The experience hopefully either reinforced or helped identify your willingness to take risk. There are numerous studies on emotions identified as markets move. In fact, if your feelings about losing value are different than your feelings when your investments are gaining value, you identify with a behavioral economic theory called "prospect theory" or sometimes also referred to as "loss-aversion".
The Investopedia website (www.investopedia.com) defines prospect theory in the following way:
Prospect theory assumes that losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses. Also known as "loss-aversion" theory, the general concept is that if two choices are put before an individual, both equal, with one presented in terms of potential gains and the other in terms of possible losses, the former option will be chosen.
At Baron, we want to help clients avoid behavioral mistakes through education. Even though willingness is an important component in identifying your investment strategy, another component, ability to take risk, is as important or more important when determining your investment strategy. The only way for us to fully understand your ability to take risk is to develop a customized comprehensive financial plan for you. Want to learn more…ask us.
A Global Perspective
A core objective for our customized Baron Financial Group investment strategies is global diversification. Global diversification means including investments based both domestically in the U.S., as well as internationally in developed and developing countries.
There are popular benchmark indexes that provide perspectives about performance of global investments. For equities, we monitor the MSCI ACWI All Cap Index. This index is designed to represent equity investments across 23 developed and 24 emerging markets. In the first quarter, the index was up 12.27%. For fixed income, or bonds, we track the FTSE World Government Bond Index. The index tracks sovereign debt from 20 countries, denominated in their respective currencies and was up 1.74% in the first quarter.
Though the equity markets flashed warning signs for the economy in the fourth quarter, data still remains solid. Equity-market fears eased as economic data was released and the Fed signaled a more accommodative stance. These factors led to stock prices rebounding in the first quarter of 2019.
The Bureau of Economic Analysis (BEA) announced in its third estimate for the fourth quarter of 2018 that real gross domestic product (GDP) increased 2.2%. This was a reduction of 0.4% from the initial estimate received in February. This was also a lower measure than the 3.4% recorded for the third quarter of 2018. The news release, however, surmises that the “general picture of economic growth remains the same”.
GDP is a measurement of what has already happened. There are, however, statistical measures that give insight into the future. One of those measures is The Conference Board Leading Economic Index® (LEI) for the U.S. The index is an analytical tool that helps signal peaks and troughs in the business cycle. The February LEI, released on March 21st, was up 0.2% to 111.5 (2016=100), following no change in January, and a 0.1% decline in December.
“The US LEI increased in February for the first time in five months,” said Ataman Ozyildirim, Director of Economic Research at The Conference Board. “February’s improvement was driven by accommodative financial conditions and a rebound in stock prices, which more than offset weaknesses in the labor market components. Despite the latest results, the US LEI’s growth rate has slowed over the past six months, suggesting that while the economy will continue to expand in the near-term, its pace of growth could decelerate by year-end.”
We first shared the chart below in our fourth quarter letter and believe it is important to continue to track. The blue line represents the LEI, dating back to the year 2000. Since then, we have had two official recessions, which are identified by the shaded gray area. A recession is typically defined as two consecutive quarters of negative economic growth. Using the last two recessions as a gauge, we believe that the chart suggests that there was significant erosion in the LEI (blue line moved lower) prior to the economy realizing negative growth. Though this is only one tool, we would conclude that economic signals, such as the LEI, suggest that opportunities for economic growth remain and that a recession in the near-term is unlikely.
The full release from the Conference Board can be found at:
According to the Bureau of Labor Statistics (BLS), the U.S. added 196,000 jobs for the month of March and the unemployment rate was 3.8%. The increase in jobs represented a significant turnaround from February's 33,000 (revised upward from the original 20,000 number reported). Notable gains were in healthcare and professional and technical services. Job growth averaged 180,000 per month for the first quarter.
The Conference Board Consumer Confidence Index® decreased in March to 124.1 (1985 = 100) from 131.4 in February.
“Consumer Confidence decreased in March after rebounding in February, with the Present Situation the main driver of this month’s decline,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “Confidence has been somewhat volatile over the past few months, as consumers have had to weather volatility in the financial markets, a partial government shutdown and a very weak February jobs report. Despite these dynamics, consumers remain confident that the economy will continue expanding in the near term. However, the overall trend in confidence has been softening since last summer, pointing to a moderation in economic growth.”
The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was up 13.65% in the first quarter, which was a very close reversal of the 13.52% negative return in the fourth quarter of 2018. The Federal Reserve taking a much more dovish tone (accepting or promoting lower interest rates) was a main factor in the first quarter. Lower interest rates are typically considered an incentive for economic growth, which tends to be good for stocks. First quarter earnings that will be reported starting in April will be closely watched, since expectations for earnings were significantly reduced during the volatile fourth quarter in 2018.
International developed country equities (such as those in the European Union), measured by the MSCI EAFE index, produced positive results for the first quarter. The index was up 9.98%. Non-developed, or emerging countries (such as China, India, Brazil or Russia) measured by the MSCI EM index, was up as well, gaining 9.91%.
Since the end of 2017, we have heard that international-equity investments appear cheap, on a relative basis, to U.S.-based investments. Though still underperforming the U.S, international equities were able to generate positive returns even though economic growth outside the U.S. remains a concern. We think the relative valuations had a big part in performance. Looking forward, there are some discussions occurring that suggest growth may be turning around outside the U.S. If achieved, you would expect to see international-equity investments outperform.
U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, produced a positive 2.94% return in the first quarter.
The 10-year U.S. Treasury bond was 2.41% at the end of the first quarter, which is lower in yield than where it began the year at 2.69%.
With the Fed Reserve (Fed) indicating a pause/stop in raising rates, investors took that as an opportunity to invest in bonds, driving prices higher and yields lower. Speculation about why the longer-term rates moved lower, ranged from acceptance of a lower interest-rate environment to buying U.S debt that looks attractive relative to yields offered outside the U.S., to concerns over future economic growth.
Though the Fed paused/stopped raising short-term interest rates and investors bought longer-dated bonds, interest rates for different maturities are acting very differently. Short-term rates have been going up with the previous Fed-rate increases while longer-term rates have remained within a tighter range. If you plot interest rates versus the time-to-maturity to earn those rates, you have created what we call a yield curve. In previous newsletters we have written, in great detail, about the changing shape of the yield curve and what that may signal. Specifically, we follow the shape of the yield curve (plot of interest rates for different time periods). Using the U.S. Government 2-year bond rate as a proxy for short-term rates and the 10-year U.S. Government Bond rate as a proxy for long-term rates, we calculate the difference between the rates, which provides a possible indicator for the future direction of the economy. A steep (long-term rates higher than short-term rates) and wide spread, indicates possible future economic expansion and fixed-income investors are compensated for taking longer-term risk. A flat spread (long-term rates match short-term rates) is a possible indicator of economic uncertainty and longer-term investors are not being compensated for investing in longer-dated securities. An inverted spread (short-term rates are higher than long-term rates) possibly indicates future economic contraction.
We should be specific in noting that we have been using the 2-year and 10-year rates as the main data points. At the end of the first quarter, most U.S. bonds/bills rates with maturities of 1-year or less were greater than the 2-year rate. So you may have heard serious discussions about an inverted yield curve. We will stick with our data points for our discussion, but recognize that there may be some news/research outside of this newsletter that sounds different. Currently, the shape of the yield curve is fairly flat, on a relative basis, meaning long-term rates are slightly higher than short-term rates. As noted, the 10-year bond finished at 2.41%, while the 2-year ended the first quarter at 2.27%, a mere difference of 14 basis points ((bp) a basis point represents 1/100 of 1%). This suggests the bond market is uncertain about the future of the economy. The changing shape of the yield curve has really been occurring since at least 2014, when the spread between the 2-year and 10-year was over 220 basis points. We will continue to watch the shape of the yield curve as one of the many signals of a changing economy.
Housing and Real Estate
Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index was the strongest performing asset class that we monitor, producing a positive 17.17% return.
Knowing local markets is best for understanding values of residential housing.
According to Freddie Mac (FM), the average 30-year residential home mortgage rate moved lower to 4.06% near the end of the first quarter. The rate was higher at 4.51% (close to a seven year high) when we shared our fourth quarter newsletter. The lower rates may have a positive impact on the housing market.
The Bloomberg Commodity Index (BCOM) rebounded in the first quarter, gaining 6.32%. Energy-related investments helped support this asset class.
Natural Resources serve as an expected hedge against inflation and offers statistical benefits to portfolios. We continue to monitor all of our asset classes to determine the importance and relevance for our strategies for clients.
Baron Client Strategies
There was a study completed by Vanguard in 2016 that attempts to quantify the value of working with a professional advisor. One of the greatest potentials for value identified is the advisor’s ability to create an appropriate investment strategy that a client can stick with. This includes helping to control behavioral issues that come up along the way. We think this value became completely clear as we moved through the 4th quarter of 2018 and the first quarter of 2019. Sticking with a globally-diversified strategy that is risk-appropriate worked. Even when it may have seemed the most difficult to do so (think December 24th).
Admittedly, the recovery in capital markets was quick and this may not always be the case. But sticking with our strategies for clients should have resulted in recapturing any downside experienced in the fourth quarter by staying invested in the first quarter.
The process of our investment strategies is dynamic and the basic tenets remain: Create a globally-diversified and risk-appropriate strategy. Validate the investment choices versus peer investments. Rebalance when needed. Test the strategy in a comprehensive financial plan and have regular feedback loops to update information.
Your service plan
One of our primary roles is to educate our clients to make informed decisions about reaching their goals. Critical to that process are plan reviews, a process that focuses our attention on your goals, takes account of any changes in your situation and allows us to alter the course as necessary. For more specifics, check out our “What You Can Expect” document by clicking on the button below.
Your Personal Economysm
You may have heard us say that we are happy to help clients with issues outside of investing that may have an impact on their financial lives. We say things like “Lean on us when you are making a decision with anything with a dollar sign involved”. So we have decided to add this new section as a reminder of all of our services and to share ways in which we can help clients outside of investing.
Social Security Planning: When inquiring at your local Social Security office, the agent may or may not mention additional benefits that are available to you. Lean on us to help analyze your situation and see if you are entitled to additional benefits. We can provide you guidance with the wording to ask appropriate questions when you go to your appointment. In some cases, Social Security may need to hear specific wording to communicate available benefits. As always, please feel free to lean on us with anything associated with a dollar sign.
Knowing your willingness and ability to take risks in investing are key components to developing an appropriate customized investment strategy. Controlling your behavior and having regular feedback loops to update information are key activities to help stay on track to working towards financial success. An added benefit our clients have with working with Baron is that we are fiduciaries; we work in the best interest of our clients, and are constantly working toward maintaining the highest level of trust.
We are excited to unveil a new look to our website (www.baron-financial.com). Our goal was to create a cleaner, easier-to-navigate, and more modern look, with the same educational content. If you haven’t already, please take a look at our website blog for helpful educational articles on a wealth of financial topics. The blog contains a search function to aid in finding your topic-of-interest. Over the next month or so, we will be adding some of the older educational blog posts to the new site. Our Responsible Guidance e-mail contains our latest blog posts. As always, we encourage education and communication with our clients.
One important and exciting new addition to our website is the online client-portal tab, which will allow you access to view your account information. The client login requires a user name and password to gain access through the portal. Please let us know if you would like to create your portal login or if you would like to learn more about what the portal provides.
At this time we are also very happy to introduce two new valued members of the Baron Team: Angela Ludvigsen and Johanna Valdueza. Both have recently joined Baron as Client Relationship Associates and we welcome them to the team! You can read more about Angela and Johanna on our website at baron-financial.com/about-us/our-team. They look forward to meeting you at your next review meeting or at our upcoming Casino Night. We hope you can join us for this annual client-appreciation event on May 9th. If you haven’t already responded, please contact Fran at firstname.lastname@example.org or by calling the office at 866-333-6659.
For those of you who were able to attend the Spring Training Game in Sarasota in March, we hope you enjoyed the day! We enjoyed the exciting game, the good food, the visit from “The Bird”, and most importantly, the good company! As a thank-you to our clients and friends, a donation was made to the All Faiths Food Bank in Sarasota.
Please contact us if you would like a copy of our current registration (ADV) with the Securities and Exchange Commission.
Baron Financial Group, LLC
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 8th, 2019, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Baron Financial Group to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results. Therefore, an investor’s individual results may vary significantly from the benchmark’s performance.