Quarterly Letter to Clients

The first three months of the year would not be described as boring by any stretch of the imagination.  With the war in Ukraine continuing to create global uncertainty and the government-assisted closing of two of the largest regional banks in history, there is plenty to capture our short-term focus.  But even with these and other events, many stock indexes are up since early January and bond prices have seen some recovery as interest rate pressure has eased a bit. The point is that sometimes investment returns can tell a different story than does the current headlines.

However, whether the numbers are up or down in any given year, we caution against letting them alter your mood, or as importantly, your portfolio mix. Because, when it comes to future expected returns, short term performance is among the least significant determinants available.

Thumbs Down…Thumbs Up

In the thumbs-down category, U.S. stock market indexes1  turned in annual lows not seen since 2008, with most of the heaviest big tech stocks2 taking a bath. Bonds fared no better, as the U.S. Federal
Reserve raised rates to tamp down inflation. The U.K.’s economic policies3 resulted in Liz Truss becoming its shortest-tenured prime minister ever, while Russia’s invasion of Ukraine and China’s continued COVID woes kept the global economy in a tailspin. Cryptocurrency exchanges like FTX4… well, you know what happened there.

On the plus side, inflation has appeared to be easing slightly, and so far, a recession has yet to materialize. A globally diversified, value-tilted strategy5 has helped protect against some (certainly
not all) of the worst returns. An 8.7% Cost-of-Living Adjustment (COLA)6 for Social Security recipients has helped ease some of the spending sting, as should some of the provisions within the newly enacted SECURE 2.0 Act of 2022.

Recency Bias

Now, how much of this did you see coming last January? Given the unique blend of social, political, and economic news that defined the year, it’s unlikely anything but blind luck could have led to accurate
expectations at the outset.

 In fact, even if you believe you knew we were in for trouble back then, it’s entirely possible you are altering reality, thanks to recency and hindsight bias. The Wall Street Journal’s Jason Zweig7 ran an experiment to demonstrate how our memories can deceive us like that. Last January, he asked readers to send in their market predictions for 2022. Then, toward year-end, he asked them to recall their predictions (without peeking). The conclusion: “[Respondents] remembered being much less bullish than they had been in real time.”

In other words, just after most markets had experienced a banner year of high returns in 2021, many people were predicting more of the same. Then, the reality of a demoralizing year rewrote their memories; they subconsciously overlaid their original optimism with today’s pessimism.

What have we learned?

Where does this leave us? Clearly, there are better ways to prepare for the future than being influenced by current market conditions, and how we’re feeling about them today. Instead, everything we cannot yet know will shape near-term market returns, while everything we’ve learned from decades of disciplined investing should shape our long-range investment plans. 

In other words, stay informed but be careful to not be swayed into a reactive decision. Keep your long-term lenses on and your future self will thank you for it.
 

As we head into a new quarter, always know that we are here to help and are grateful for your
continued trust.

Josh

 

Quarterly Letter to Clients

Well, we made it to 2021 so how are you feeling?  The start of a new year can breed hope for new possibilities.  Even though 2020 was oppressive to most in so many ways, I do think we can still hold hope for the new year.  I have never been one to focus on New Year’s resolutions as they always felt like a recipe for disappointment (I know that is not the case for everyone, though).  What I am striving for this year is not new resolutions, but rather strengthening routines.  Routines feel more in my control, and if 2020 taught anything, it is to control what we can control.  One of these areas for me is to practice gratitude.  I have begun by thinking of 3 things I am grateful for each night before I go to sleep.  It is refreshing and encouraging to think on these things.  When we talk later this year, feel free to check on my progress with this.  This is just one small example, and I am sure that you have others that jump to your mind.  Let me encourage you to pursue practices like this for the sake of your own mental health in 2021.

Speaking of control…

You likely have heard us say in the past that market performance is not an area that any of us have control.  Because of this, it is wasted energy to focus and worry about market movements.  You should spend that energy doing things you can control: spend less than what you make, avoid debt, build cash reserves, plan your generosity and plan your future – practical principals that have an outsized impact on your life.

Small, quiet acts

Whether the temptation is to abandon a free-falling market (like the one we encountered less than a year ago), or chase after winning streaks, an investor’s best move remains the same.  Concentrated bets on hot hands generate erratic outcomes, which makes them far closer to being dicey gambles than sturdy investments.  Trust instead in the durability of your carefully planned investment portfolio. Focus instead on small, quiet acts.  That is what we are here for, for example, to:  
  • – Remind you that your globally diversified portfolio already holds an appropriate allocation to Tesla stock (which may be a lot, a little, or none, depending on your financial goals.
 
  • – Guide you in rebalancing your portfolio if recent gains have overexposed it to market risks.
 
  • – Help you interpret the 5,600 pages of the newly passed Consolidated Appropriations Act, 2021, so you can manage your next financial moves accordingly.
 
  • – Assess potential ramifications of the Biden tax proposals and advise you on any additional defensive tax planning that may be warranted for you in the years ahead.
 
  •  -Remain by your side as you encounter whatever other challenges and opportunities 2021 has in store for you and your family.
  These are not loud acts that you will read about in the paper, but they are the stuff financial dreams are made of.  2021 will be interesting to say the least, but let’s hold onto the hope and possibility that a new year brings.  Stay healthy, stay grateful and know that we are here to help.   Josh, Mike, Matt and Sandra  

Volatile equity markets, falling bond yields, and the coming recession: A letter to our clients

By Matt Miner

August 15, 2019

Dear Clients,

First, THANK YOU for your business with PLC Wealth Management! We are honored to serve as your advisors and to walk through life with you.

Second, we think today is a good day to talk with you about jumpy stock markets, falling bond yields, and our thoughts regarding the US economy. Our letter wraps up with actionable advice for you to implement immediately. Pretty exciting, right?

As I prepared to join my family for dinner last evening, I received a forwarded email. According to a tweet by advisor Michael Batnick, yesterday was the 307th time that the Dow fell 3% or more in a single day, over the course of the last 100 years. To see the folks on CNBC jumping up and down, wild eyed and foaming at the mouth, you could be forgiven for imagining that the entire US economy been vaporized.

Volatile Stock Markets

On average a downward move of the magnitude we experienced yesterday happens 3.07 times each year. Equity markets have been mostly placid over the last decade, and yesterday’s market decline was the first drop of that size in 2019. But if we simply achieve historically average volatility, we can expect two more moves of the same size before we celebrate New Year’s Day 2020! Said differently, drops of 3% come around slightly more than three times as often as Christmas.

For a different comparison, UNC and Duke always get invited to the NCAA Men’s Basketball Tournament. In each program’s history, UNC has played 160 NCAA tournament games and Duke has played 147 NCAA tournament games. Coincidentally, the Dow Jones Industrial Average has declined 3% or more in a single day in the last 100 years the same number of times as the two most storied programs in college basketball have played a game in the NCAA tournament: Many, many, times! Stock market volatility is table steaks. It’s why investors expect to earn a positive return for investing in stocks.

The Russell 3000, one of our preferred index comparisons, was down 2.89% yesterday and is down 4.85% for the month. No one likes that. But the same index is up 14.63% in 2019, 9.53% per year on a rolling five-year basis, and 13.20% per year on a rolling ten-year basis (ftserussell.com as of 8/14/2019 market close).

The stock market can be a rough ride, but it has reliably propelled investors’ wealth upward over time. The chart below shows the growth of one dollar from 1970 to 2017 invested in one-month T-Bills, the S&P 500 Index, and in a globally diversified stock portfolio, similar to PLC Wealth’s equity investment style.

Friends and neighbors, you only get hurt on a roller coaster if you jump off.

Falling Bond Yields

It is true that bond yields have fallen, meaning that money invested in the bond market today earns less interest than it did at this time last year. This has resulted in strong appreciation of bond funds (bond prices move in an inverse relationship to bond yields). For example, DFAPX, an investment-grade bond fund, has appreciated 7.81% in 2019, something I did not expect as we entered this year. On the other hand, falling rates mean that maturing bonds will be reinvested at lower interest rates than bonds that matured in the recent past. It also means that interest rates earned on assets like money market funds, certificates of deposit, annuities, and savings accounts have been reduced.

The Yield Curve

What about the ever-famous inverted yield curve? Once you finish this article you’ll be able to amaze your friends and confound your enemies because you’ll know the answers to questions like, “What is a yield curve?” and “What is an inverted yield curve?” and “What does a yield curve inversion mean?” and most meaningfully, “What should I do?”

First, a yield curve plots the returns investors expect on debt over different periods of time – for example one, five, ten, and thirty years. Investors normally demand to be paid more to loan their money for longer periods. You may have experienced this as a consumer: 30-year mortgage rates are higher than 15-year mortgage rates. This is because the longer the loan, the greater the investor’s exposure to the vagaries of inflation, the risk that the borrower fails to repay, and the risk that the money is locked up at a time the investor wants liquidity. In the graphic below, the August 2018 yield curve (the line with the gray diamonds) is the most “normal” looking, even though the rates are low by historic standards.

Second, an inverted yield curve like the blue line with dots, labeled “Current” in the graph above, means that investors demand 2% to loan to the US government for one year, but only ~1.65% to loan for ten years. How can this be? The inverted yield curve signals that bond investors expect poor economic performance resulting in low interest rates over that time period.

Third, an inverted yield curve has accurately predicted economic recession (two or more quarters of negative growth) or an economic slowdown (a reduction in the growth rate) with 100% accuracy going back to the Eisenhower administration. The predictive value of the inverted yield curve is particularly potent if the inversion lasts for more than one full quarter which is the case as I write you this letter.

Here’s the unvarnished truth: A recession is coming. A recession is always coming. What we don’t attempt to do is predict when the recession will arrive. The fact that a recession is coming is part of your plan. When you work with an advisory firm like PLC Wealth, your plan includes the expectation of recession. It’s kind of like knowing you’ll need to replace your car. You don’t know exactly when you’ll need a new car, but you’ll need one sometime. By planning with PLC Wealth, you have prepared for recession.

Cam Harvey, a terrific professor at my business school alma mater – Duke’s Fuqua School of Business – was quoted yesterday by WRAL saying, “Maybe this is not the right time to max out your credit card…Maybe it’s not the right time to take the vacation with your family that is going to overextend you.” Professor Harvey goes on to recommend you “[do] 100% effort at your job.”

At PLC Wealth we never recommend you max out your credit card. Instead, we recommend you negotiate discounts and pay cash!

We love vacations, but we don’t recommend you overextend yourself to take one. Go camping if that is what your budget supports!

Putting in 100% effort at work is timeless advice your dad gave you, too.

Call to Action

What should you do to prepare for the coming recession? For that matter, what should you do to prepare for the coming prosperity? The advice does not change. Do excellent work. Live on less than you make. Invest the difference wisely. Make a good tax plan. Bless your family with a thoughtful estate plan. Prepare for catastrophe with suitable insurance and emergency funds. Care for your health. Spend time with the people you love. Live according to your values. Be kind.

If you have questions about market volatility, bond yields, or the coming recession, give us a call. We are here to help with any topic where life meets money. Once again, thank you for your business with PLC Wealth Management.

January 2019 – Quarterly Review: “Average returns” are rare

What if Charles Dickens had begun his classic “Tale of Two Cities” as follows: It wasn’t the best of times, it wasn’t the worst of times, it was the usual mixed bag.

While the statement may reflect reality, it doesn’t grab your attention half as well as Dickens’ actual opening sentence describing the French Revolution. As he concluded about the period, “some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”

Thus, we’ve long known about our infatuation with extremes – Best! Worst! Delight! Despair! These are the sentiments that fuel our dreams and inspire our works of art. But you do yourself a disservice if you allow superlatives to rule your investing. In capital markets, if you get caught up in extremes and devalue the sweeping tides of time, you risk giving up your greatest edge: a clear-eyed understanding of what’s really going on.

As we reflect on the events of 2018, here are two evidence-based points worth repeating:

1. “Average” annual investment returns aren’t typical; in fact, they’re rare.

To quote a more contemporary source than Dickens, Cliff Asness of fund manager AQR recently observed: “This world is pretty much designed to convince us that we’re always at DEFCON 1, when 5 is the mode and 4.5 the mean.”

Other year-end analyses concluded that market volatility for 2018 remained on the low side. Even the wilder swings toward year-end were not that remarkable in the grand scheme of things.

And yet, many “noisiest authorities” have been quick to play up the superlatives, while downplaying how these sorts of best of times, worst of times conditions have long been more the norm than the exception in capital markets. As expressed in this Forbes column, “when you take the long view – and if you’re a long-term investor, then you should – you’ll see that what feels jarring right now is actually just a return to normal levels of short-term volatility.”

This brings us to our second point.

2. You are human; you are susceptible to recency bias.

While there are many behavioral biases that trick us into sabotaging our best financial interests, we’re especially interested in the damage recency bias could cause in current conditions.

Recency bias can trick your brain into downplaying decades of robust market performance data, while magnifying the run of unusually calm market conditions we’ve been enjoying relatively recently – essentially since March 2009. This in turn may lead you to lend more weight than is warranted to current volatility.

That’s not to say the ride will be fun if we encounter more turbulence ahead. But by remembering extremes are actually the norm in your quest to generate durable long-term returns, you stand a much better chance of preserving your objective perspective and your portfolio, come what may.

We are grateful for the opportunity to remain at your side, ever eager to advise your course through whatever the markets have in store for us in 2019 and beyond. How can we help? Let us know!

Reflections on 2018 and the stock markets renewed volatility…

If you were a member of the popular press, you’d probably be happy with 2018’s first quarter performance. At last – some volatility fueling news1 in early February, with plenty of enticing “largest,” “fastest,” and “worst” market superlatives to savor after a long, languid lull.

As usual, there are plenty of potential culprits to point to among current events: global trade wars heating up, the arrival of quantitative tightening (rising interest rates), troubles in tech-land over data privacy concerns, ongoing Brexit talks, and some interesting events over in the Koreas. At quarter-end, one hopeful journalist asked, “Is the Bear Market Here Yet?”2 Another observed: “[T]he number of [Dow Jones Industrial Average] sessions with a 1% move so far in 2018 are more than double 2017’s tally, and it isn’t even April.”3

Has the coverage left you wondering about your investments? Most markets have been steaming ahead so well for so long, even a modest misstep may have you questioning whether you should “do something,” in case the ride gets rougher still.

If we’ve done our job of preparing clients and their portfolio for market jitters, clients may might be able to cite back to us why they’ve already done all they can do to manage the volatility, and why it’s ultimately expected to be good news for evidence-based investors anyway. Remember, if there were never any real market risk, you couldn’t expect extra returns for your risk tolerance.

That said, you may have forgotten – or never experienced – how awful the last round of extreme volatility felt during the Great Recession. Insights from behavioral finance tell us that our brain’s ingrained biases cause us to gloss over those painful times, and panic all over again when they recur, long before our rational resolve has time to kick in.

If you noticed the news, but you’re okay with where you’re at, that’s great. If the volatility is bothering you, talk to a CFP® professional or other qualified financial professional; it may help ease your angst. If you continue to struggle with whether you made the right decisions during quieter markets, plan a rational shift to better reflect your real risk tolerances and cash-flow requirements. Not only is your peace of mind at least as important as the dollars in your account, you could end up worse off if you’ve taken on more risk than you can bear in pursuit of higher expected returns.

As Wall Street Journal columnist Jason Zweig said during the February dip: “A happy few investors … may have long-term thinking built into them by nature. The rest of us have to cultivate it by nurture.”  We couldn’t agree more, and we consider it our duty and privilege to advise you accordingly, through every market hiccup.