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February Market Insights

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Market Update

There are a number of positives contributing to this robust bull market entering its 9th year. Consumer sentiment is at a 17 year high, while unemployment is at a 17 year low. Wage growth picked up to 2.9% in January, its strongest pace since the recession.  We also had the best January since 1997, with the S&P 500 finishing the month up 5.7%. The story–global synchronized growth.  US corporate and personal tax reform, the first we’ve had since 1986.

February Sell-Off (Updated 3/18/20)

But February is off to a rocky start with a sizable sell off having wiped out all 2018 gains in the markets.  We’ve finally broken the streak of 81 straight weeks without a correction of more than 5%.  Commentators are reminiscing about Black Monday, August 24, 2015 when the Dow fell over 1,000 points only to recover some of its losses and finish the day down 588 points.  At the time, America hadn’t had a point drop of that magnitude since October 2008, when the financial crisis was in full effect and people were gravely concerned that more banks like Lehman Brothers would also collapse.  The following day, August 25, 2015 markets continued their downward plunge with the Dow dropping another 215 points.

It’s important to take note of what happened in the days ensuing.  August 26th and 27th of 2015 saw massive rallies of 609 points and 370 points respectively for the Dow, recovering all losses from the days prior!

We’re actually seeing the same pattern take place in February 2018. In just two days of trading in February (2nd and 5th) the Dow retreated -541 points (-2.07%) and -1,175 points (-4.6%), respectively, catching many investors off guard and left to wonder, is this the beginning of the next major financial crisis?  Only to rebound the very next day, February 6th when the Dow gained 567 points (+2.33%) erasing some of the losses from Monday’s rout.  This should remind investors that trying to time the market is a losing proposition.  If you cannot tolerate or afford these day-to-day whipsaws and market volatility, you probably shouldn’t be invested in the markets in the first place!

Drops of this severity are becoming commonplace as quantitative investment and growth of passive investing strategies continue to grow in popularity at the expense of fundamental stock selection.

According to a Wall Street Journal feature back in May 2017 called, “The Quants,” Quantitative investment strategies are now responsible for 27% of all U.S. stock trades by investors, up from 14% in 2013.  Furthermore, passive and quantitative investing account for about 60% of trading, more than double the share a decade ago.  Just 10% of daily trading volume can be attributed to stock pickers–individuals and professional fund managers.

But in the high frequency, computer driven trading world we live in, and with passive investment strategies continuing to garner the lions share of investor assets, such wild market swings have been, and will become more and more commonplace.

At this point, you may be asking yourself, what can I do to protect my portfolio should we go through a 10-20% correction? Well, for starters, don’t rely on a Robo Advisor strategy to protect your portfolio as they consistent entirely of passive investment strategies designed to track the markets.

Robo Advisors: Limited Downside Protection

In a blog post back in July of 2017 I warned readers that a bubble is forming in passive investing and may have serious consequences for investors.  I feel that this is an opportune time to remind you that a portfolio of passive exchange traded funds (ETFs) offered by the likes of Betterment and Wealthfront offer little to no downside protection from a major market downturn.  Such Robo Advisor strategies are not nimble, as they are designed precisely to attain market-like returns by using low-cost index funds.  Sure, they offer different mixes of passive investment strategies based on the answers provided from a cookie cutter questionnaire, but many were created after the great recession of 2008-09 and have yet to experience a major market downturn.

From personal experience, I can tell you how important it is to be selective with what you buy this late in the bull market and especially with valuations where they are.  Owning the markets since 2009 has worked out quite well for investors.  Get this–the S&P 500 hasn’t had a negative year since 2008, when Taylor Swift was only 19 years old.  Wow!

Past 5 Major Crises

For my clients, I’m going back to the drawing board, and using a proprietary portfolio analytics software (see image below) to stress test portfolios so we can better understand how they performed during the last 5 major crises:

      1. Asian Crisis of 1997
      2. Russia/Long Term Capital Management fiasco of 1998
      3. Tech Bubble of 2000-01
      4. World Trade Center Attack of 2001
      5. Subprime Crisis of 2008-09.

If you’d like to have your portfolio analyzed so you can better understand the risk you’re currently taking, schedule time on my calendar.

Bear Market Checklist/Recession Indicators

While we’re on the topic of risk, allow me to share a checklist I periodically review to make sure I’m not caught off guard by the next recession.

The two most accurate predictors of a recession being:

      1. Inverted Yield Curve. This occurs when the 10 year treasury and 2 year treasury note invert.  It’s more of a yellow flag, as historically it takes 18 months after an inverted yield curve to see a recession occur.  Historically after the yield curve inverts, there’s another 18 months with average returns of 40%.  So moving to cash would be a mistake.
      2. 10 Conference Board Leading Indicators begin to show signs of slowing down.

Other important indicators include:

      • Elevated Valuations
      • Extreme reading in consumer bullish sentiment/investor optimism
      • M&A/IPO Market Boom
      • Steep declines in: ISM Manufacturing, Service PMI dips below 50
      • Credit Spreads widening. Yield spread between high yield bonds and treasuries
      • Defensive Stocks/Sectors outperforming
      • Strong inflows into equity funds
      • Inverted Yield Curve. When short-term rates rise above long-term levels
      • Uptick in initial unemployment claims

So far, we can only check the boxes for Elevated Valuations and Strong Inflows into equity funds.  In my opinion, not enough to trigger a recession.

8 Stocks that Delivered Positive Returns in 2008

Finally, as promised, I’ve compiled a portfolio of 8 stocks that provided positive performance (and lower volatility) in 2008, while the markets proceeded to drop 37%.  And if you actually look over a 20 year period, this portfolio of 8 defensive stocks has provided annual returns of 12.88% while the S&P 500 has returned 4.79% annualized (updated to reflect 3/17/20 closing numbers).

This is not meant to serve as a recommendation to buy the 8 companies listed, nor to suggest that these 8 particular stocks are entirely recession (fail) proof when we do indeed experience the next recession.  But these companies share a few commonalities that historically made them relatively stable holdings when seemingly everything collapsed.  They provide products (consumables) many would consider as necessities, preventing them from being dependent on a healthy economy.  Think of things you can eat, drink or smoke.

Remember, if you’re invested in the markets, it’s about the long game.  Ignore the short-term noise.  Don’t let this recent correction get in the way of sticking to a sensible investment plan.  And certainly don’t allow yourself to get whipsawed by these drastic day-to-day fluctuations!

Aaron L. Hattenbach, AIF®
Managing Member
Rapport Financial

The opinions expressed herein are those of Rapport Financial, LLC (RF) and are subject to change without notice. Past performance is not a guarantee or indicator of future results. Consider the investment objectives, risks and expenses before investing.

You should not consider the information in this letter as a recommendation to buy or sell any particular security and should not be considered as investment advice of any kind. You should not assume that any of the securities discussed in this report are or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the securities listed in this newsletter. These securities may not be in an account’s portfolio by the time this report is received, or may have been repurchased for an account’s portfolio. These securities do not represent an entire account’s portfolio and may represent only a small percentage of the account’s portfolio. partners, employees or their family members may have a position in securities mentioned herein.

Rapport Financial was established in 2017 and is registered under the Investment Advisors Act of 1940. Additional information about RF can be found in our Form ADV Part 2a.

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5 Questions to Ask Your Financial Advisor

I was recently in a meeting with a new client where we went over the scope of my services, and what I charge for advising my wealth management clients. It’s always been my practice to provide a transparent and detailed description of my fee structure so clients know exactly what they are paying me to advise them and manage their assets. With that said, here are the first 5 questions you should be asking a financial advisor before signing any legal documents:

1. What are ALL the ways that you and your firm are compensated for your services, and are they fully disclosed?

How much you’re paying for the management of your assets shouldn’t be a mystery, but usually this is anything but an easy answer for most providers. I can’t tell you how many times I’ve asked prospective clients, “what do you pay your current advisor” and draw a blank stare. Would you ever purchase a product without first knowing its price?

If you’re speaking with an Independent Advisor ask for their Form ADV Part 2. You can access this directly on the SEC website: https://www.adviserinfo.sec.gov/.

Remember, if you don’t know exactly how much you’re paying, you’re almost certainly paying too much!

2. Does your compensation depend on the investment strategies that you recommend?

The fees paid for different investment products can vary significantly, ranging from very little (indexed ETFs), to modest (active mutual funds), to exorbitant and very often unnecessary (derivatives, structured notes, annuities, hedge funds). This can bias recommendations towards more expensive investment products.

Your advisor should have no economic interests in the investment strategies they recommend!

3. What conflicts of interest do you face in advising me?

The answer should be none. Most financial advisors are not fiduciaries. Instead, they are outside sales agents for banking institutions with sales quotas in an antiquated business model.

Consider hiring a Fee-Only Registered Investment Advisor. An advisor working in this model is required by law to act in a fiduciary capacity and put their clients’ financial best interests first. The Fee-Only advisory model aims to remove many of the conflicts of interest found within traditional brokerage firms, i.e. UBS, Merrill Lynch, Morgan Stanley, etc.

4. How will you evaluate the success or failure of my portfolio over time?

This shouldn’t be just a performance number relative to the stock market, but rather whether the portfolio has met your stated goals, income and liquidity needs, tax considerations, liabilities, risk tolerance and other factors or preferences specifically addressed in your Investment Policy Statement.

This is only possible if these matters have been formalized in an Investment Policy Statement that defines the purpose of the portfolio and how it will be organized, formalized, implemented and monitored. As a part of the Investment Policy Statement, specific indices and benchmarks (S&P 500, Barclays Aggregate Bond, etc.) should be defined for the evaluation of performance so that no ambiguity will exist. Risk management is both the most crucial part of portfolio construction and the only real aspect that can be controlled — get the downside risks covered appropriately and the upside will take care of itself.

As one of my mentors used to say, “Don’t confuse a good advisor with a bull market!”

5. What services does your firm provide besides investment advisory?

Wealth Management/Investment Advisory is a full-time job. Be highly skeptical of firms that offer a number of unrelated or tangentially related services such as insurance, estate planning, tax preparation, banking, credit, etc. It is difficult for any firm to have more than a single core competency, and efforts to do otherwise typically lead to sub-standard offerings. The consolidation of the financial services industry has profited service providers more than their customers as its goal is to create cross-selling opportunities rather than a quality and customized service offering.

Financial advisory services should be more than just the core competency of the firm you work with, it should be the ONLY competency.