The Value of Portfolio Management in Interesting Times
One of the values of having a financial advisor is receiving customized investment management. As a firm, we’ve embraced a philosophy of patience and not letting market changes interrupt the planning strategies we’ve built around the long-term goals of our clients. It also means that it is incumbent on us to be a learning organization that diligently evaluates changes in market conditions. Below are a few key items that we’ve been monitoring and how they’ve contributed to the market volatility we’ve seen so far this year.
First, domestic corporate profitability has been very strong in 2018. 2019 earnings growth is expected to be slower than 2018, but still at above-average levels. The expectation of future profitability is a significant factor in stock market performance. Expectations of slower growth in both 2019 and 2020 would indicate that continued equity appreciation is likely but at reduced levels.
Second, the amount of investment capital that is being held in money market or cash-equivalent funds is continuing to increase. This is largely a product of institutional investment managers deciding to hold more of their total capital in cash. Over the past year, commentary from these managers has been focused on valuations. In short, they view potential investments as being expensive relative to historical averages. When managers feel that prices are high, they are more likely to wait to put cash to work.
Third, inward-looking trade policies in the US, Britain, and portions of the Eurozone have been a small drag on global growth. The exit of Great Britain from the EU is a complex, and ongoing, negotiation. If done poorly, it has the potential to harm growth in both Britain and the EU. The trade policies enacted by the US over the past several years have also added to the risk of future instability and reduced growth in both the US and its trading partners. Furthermore, there are protectionist political movements in Germany and Italy that have gained strength over the past several years. Individually, none of these issues is a substantial drag on global economic growth, but, taken together, they present a level of uncertainty that increases investment risk throughout the world.
Fourth, and perhaps the largest impact on current equity market performance, has been the rather rapid rise in US interest rates over the past two years. An increase of 1.5% – 1.75% may not sound like much, but it has effectively doubled prevailing rates. For instance, in August of 2016, the United States 10-Year Treasury rate was approximately 1.5%. Today, that rate stands just over 3%. After a decade of interest rates being ultra-low, by historical standards, a return to more normal rates has caused a repricing of a variety of different assets. Simply put, when interest rates on newly issued debt are higher, they become a more attractive investment. This can cause money from investments like stocks and real estate to flow back into the bond market. Additionally, older bonds pay less than their newer counterparts and, when traded, are priced at a discount because they are now less valuable than the newly issued debt. We anticipate that interest rates will continue to increase, but at a more gradual pace, that is dependent on continued growth in the US. It should also be noted that while the US is raising interest rates, most of the rest of the world is not. This also creates volatility as currency prices fluctuate.
Finally, demographic trends are likely going to lead to slow growth, over time, in both the global developed world as well as the US. While the millennial generation is the largest generation in US history, we are seeing a continued long-term shift in the ratio of active workers relative to retirees. The US figure currently stands at approximately 4.9 to 1, meaning there are roughly five active workers for every one retired worker. That number is projected to decline to 1.9 to 1 by the year 2100. For context, Germany currently stands at about 2.9 to 1 and is projected to decline to 1.4 to 1 in the same time period. In short, the fewer workers an economy has, the lower the economic output of the total economy. Additionally, as programs built around public retirement funds and public health systems add more beneficiaries, the cost to maintain those systems increases. Europe is several decades ahead of the US when it comes to the aging demographic trajectory. Therefore, Europe’s economic growth rates are likely to reflect what US expectations should be in the decades to come.
So what does all this mean? We expect continued moderate growth in the US economy, slow growth in the developed world, and moderate but volatile growth in emerging markets.
We continuously evaluate client portfolios. During times with elevated risk levels, like today, it is important that we maintain focus on your individual risk and volatility tolerances. If you have questions about your current risk exposure, we encourage you to contact your Wealth Management Coordinator or Advisor.
These are interesting times in which we live. Stay tuned.
Have any questions? We’re here to help!