APG Capital Asset Management 2nd Quarter 2020 Review and Outlook

The United States is still grappling with escalating Covid-19 cases, historically high unemployment, and a severe recession, all while the stock market had the best quarter in twenty-two years. With such a bleak background, this strength seems fairly bizarre but there are reasons for the S&P 500’s 20% quarterly rally to end the year down only 3%[1].  

Stock prices are determined by the present value of estimated future earnings.  Stock market valuations may imply that investors are looking past the next few quarters and that corporate profits rebound fairly rapidly in 2021 and 2022.  But with the uncertainty that exists, most of those estimates are impossible to determine so optimism over future profits only tells part of the story.

The most reasonable explanation is due to the unprecedented amount of government stimulus being pumped into the economy.  The payments to taxpayers and businesses, combined with the Federal Reserve bond buying programs (see the chart below of Fed activity), have created a flood of new money into the economy.  The effect of this is to devalue dollars, which increases inflation.  This, in turn, pushes assets like stocks, real estate and commodity prices up.  This gels with what we’ve experienced.  But stock prices should also weigh the risks of a depressed economy on the profitability of corporations and demand for hard assets.  We may be in a stage of the market recovery where the market will bounce around, finding where these opposing forces find an equilibrium.

It is useful to note how the market reacted to past pandemics.  During the Spanish Flu of 1917-1918 as shown below, the market then similarly plunged about 33%.  After the market bottomed, it quickly rebounded, traded in a range for a year, and then trended higher.  It took about 15 months for the market to fully recover the pre-virus highs.

This pandemic is forcing companies to adapt to news ways of doing business.  While many companies are struggling, there are some that are capitalizing on their market position.  Active management could have a good chance to outperform in this environment. We remain focused on growth stocks relative to value and de-risking portfolios through an overall lower weighting to stocks may be prudent.  We believe It is important to stay focused on the long term. While there may be short-term market weakness as we learn more about the wave of outbreaks and how companies are faring in the next earnings announcement cycle, it is hard to bet against the long-term ability of companies to evolve and thrive in new environments. This is especially true as long as the Fed remains highly supportive.

While the market continues to confound, we recommend paying attention to areas we can control.  Here are some things to consider:

1.       Make sure you are taking advantage of tax savings. 

• maximizing deductible 401-K and IRA contributions, (the deadline for 2019 contributions were pushed to July 15th this year

• tax-loss harvesting, and

• smart charitable giving, either to a Donor Advised fund or a Qualified Distribution from IRAs.  

2.       With the prospect of higher future tax rates, there may be opportunities converting Traditional IRA holdings to a Roth IRA.  

3.       Reviewing your mortgages to see if a refinancing makes sense

4.       Take a closer look at your expenses so there are no holes in your budgeting and cash planning.  

5.       Please stay safe - avoid crowds, wash your hands and, for the safety you and your loved ones, wear a mask.

This marks the third anniversary of APG Capital and I want to thank all of my clients for your trust and time.  I truly appreciate our collaboration and sharing of ideas.  I look forward to seeing you all in person soon.

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

713-446-3233

www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including: investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

[1] https://www.statista.com/chart/22169/change-in-us-stock-market-indices-in-the-second-quarter-of-2020/

[2] https://www.marketwatch.com/story/market-behavior-a-century-ago-suggests-the-worst-could-be-over-for-stocks-if-not-for-the-coronavirus-pandemic-2020-03-19

2019 Financial Planning Year-End Checklist

The holiday season is a time for family and reflection.  Hopefully, it will also leave some time to take stock of your finances. As the calendar resets in a month or so, it is wise to remember some important financial end of year to-dos to make sure you have maximized your situation by lowering taxes, bringing portfolios back into balance and your estate planning is up to date.  Happy Holidays and may you have a wonderful 2020!

         Consider funding a Donor Advised Fund with appreciated assets.  One larger contribution that can fund your charitable giving for many years can help push your deductions high enough to itemize, and it avoids capital gains taxes on the appreciation.

•          Harvest capital losses.  After a year like 2019 when practically all asset classes rose, it may be hard to find losses, but there are always those that struggled.

•          For those 70 ½ or older or have an inherited IRA, make sure you take your RMD to avoid paying a 50% penalty.

•          Also, for those 70 ½ or older that have Required Minimum distributions from their IRA, a preferred way to donate to money to a charity is thru a Qualified Charitable Distribution. These payments count toward satisfying your RMD for the year (up to $100,000) and are excluded from income for tax purposes.

•          If there are any changes to your estate plan or beneficiaries, make sure you will (you have one, right?) has your final wishes.

•          You have until April 2020 to make your IRA contributions, but if you already know what kind of contribution you will be making (Roth, tax-deductible traditional), now is a great time to make it. Remember, the contribution limits are up to $6,000 for those under 50, and $7,000 for those 50 and older.

•          Decide when you are making that property tax payment.  With the new lower deduction for state and local taxes of $10,000, it may not be as critical, but some still benefit from choosing which year to make the payment.

•          If you happen to have a lower-income year, take advantage by thinking about a Roth conversion. Filling up your low marginal income-tax-rate buckets with income from moving dollars from traditional to Roth IRA may pay long term benefits.

•          Reallocate your investments.  After such a strong year in the equity markets, you may be tilting a bit stock-heavy in your portfolio.  Consider taking some chips off the table and trim strong performing growth stocks in favor of value and international equities and high-quality bonds.

•          Remember the words of Bob Harris from the film Lost in Translation (2003) “The more you know who you are and what you want, the less you let things upset you.”

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  Advisory Services Network, LLC does not provide tax advice.  The tax information contained herein is general and is not exhaustive by nature.  Federal and state laws are complex and constantly changing.  You should always consult your own legal or tax professional for information concerning your individual situation.

The Growth Rally Continues: 2nd Half 2019 Outlook

The 2019 stock market rally continued in the second quarter, with the S&P 500 tacking on another 4.3%, giving the S&P a 18.5% return for the year.  With earnings tracking to a modest 2.6%[i] growth rate for 2019, this gain is mostly due to the Price/Earnings multiple expansion.  The market is clearly more expensive today than it was at the beginning of the year.  At the current forward P/E of 16.9, the market is trading slightly ahead of the 10- year average of 14.8.  A major reason for this is the Federal Reserve changing course and pumping liquidity into the market by signaling their openness to lower interest rates.  As the 10-year bond yield has dropped from 2.6% to below 1.9%, the options for investment returns have shrink in the bond market, pushing investors into other areas, including the stock market.

Growth has outperformed Value

All stock sectors though are not benefiting equally.  We have seen tremendous divergence between value and growth stocks with growth trouncing value.  Over the last 5 years, the Russell 1000® Growth Index beat the Russell 1000® Value Index by almost 6% per year (13.4% vs 7.5%). Much of the market history have favored the exact opposite.  For the prior 19.5 years, value outperformed by over 1.5%/year (10.5% vs 8.9%). [ii]

What has caused this notable performance change in Value versus Growth?  In a recent report from Ned Davis Research[iii], they point out how a number of reasons for this. First, the mere fact that value had historically outperformed had market participants overweight in this direction. This may had led to over-valuations in value stocks, in effect, removing the advantage. The second is somewhat counterintuitive.  They have found that value stock outperformance requires a stronger growth economy.  Growth stocks can grow regardless of the underlying economy, while many value stocks need a booming backdrop to succeed. This makes sense for banks, which require a decent spread between short-term rates and long-term rates, typically happening during booms. Another value sector, commodity-based companies earn excess profits when material shortages occur, also typically in a bustling economy. Since the end of the financial crisis, the economy has been slowly and steadily improving, not quite reaching the “escape velocity” that value stocks need.  

When will Value be Back in Favor?

The fact that the market has rewarded growth for an extended time may not indicate it is changing any time soon. This is, in part, due to changes in our economic cycles. As the economy has shifted from manufacturing to consumption, the economic cycles have lengthened due to the more stable consumer spending pattern versus shorter manufacturing cycles.  Even with the long period of growth, the Federal Reserve is still pumping the economy with low rates and expectations are for even lower rates in for the next few years.  In their report, Ned Davis points out 12 Indicators which help them to determine which indicators are pointing to Growth or to Value and only 2 are leaning toward Value versus 6 for Growth (4 are neutral).  Furthermore, they argue that the biggest driver of a switch is the economy reaching escape velocity. Therefore, with the Fed still needing to help the economy, they see this trend continuing. 

Here at APG Capital, I see reasons to be cautious, namely valuations are elevated and significant political risks. We are favoring a modest underweight to equities, but within our equity allocation we are sticking to a growth theme as these companies continue to disrupt industries. 

APG Capital Asset Management recently hit its 2-year anniversary and we are so thankful for the continued trust and confidence of our clients.

[i]https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_070319.pdf

[ii]  https://indexcalculator.ftserussell.com/ICStep4DR.aspx

[iii] Clissold, Ed, “US Featured Report: Will Value ever outperform again”, Ned Davis Research, May 30, 2019.

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

Phone: 713-446-3233  Website: www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

Third Quarter 2018 Review and Outlook

It was a tale of two markets in the third quarter.  US Equities markets on one hand and, seemingly, the rest of the investable universe, on the other.  US Equities rallied, as evidenced by the 7.7% surge for the S&P 500 for the quarter (+10.6% year to date)[i], while the Developed Markets eked out a 1.1 return in the quarter (-1.3% year to date)[ii] and emerging markets dropped 1.4% (-7.9% year to date)[iii]. Even domestic bonds continued their streak of losing quarters, dropping marginally in the quarter leaving the Barclays’ US Bond Aggregate Index down 1.6% for the year.[iv] 

Domestic Backdrop

The effects of lower taxes and regulation have helped sustain the economy’s growth momentum. The 4.2% growth in GDP for the second quarter may have been boosted by a “sugar high” form the tax-cut but expectations are for continued growth as the US Conference Board is forecasting a 3.1% growth rate for 2019.[v] Furthermore, as shown in the Federal Labor Market Conditions Index, the labor market has fully recovered from the Financial Crisis.

Interest Rate changes

Emblematic of this strength, the Fed has removed their “accommodative” stance for interest rates, signaling continued rate hikes.  The effect of these hikes make housing more expensive and hurts profitability for debt-laden companies. The Fed hopes that, while tempering growth, these increases keep inflation under wraps.  While the Fed makes changes to short term rates, longer term rates are set by the market.  Recently, the 10-Year rate broke out of its trading range and moved significantly higher, from about 2.80% to 3.25%.   Back in February, when we saw these rates jump higher, the market corrected sharply, but since has recovered and have shown decent gains for the year.  We may see another similar situation with the markets acting a bit jittery while the economy sorts out these countervailing impacts. 

With the expansion almost a decade old, we are certainly in the later stages of the growth cycle, but when the economy turns downward is still a question.  Positioning portfolios more cautiously is probably warranted, but we are still optimistic for the mid- and long-term for the US markets.

International Situation

The current trade policies of the US Administration are a heavy-handed approach to fix some of the unfair treatment of US companies when dealing overseas, especially when it comes to intellectual property.  Specifically, escalating tensions with China are proving to be damaging to the worldwide growth story and most markets are feeling those effects.  Hopefully the new tariffs on trade is ultimately posturing, and a more pro-trade resolution is negotiated.  Ahead of that resolution, maintaining some exposure to emerging markets should be a good risk/reward position considering the current weakness, as these markets are trading at significant discounts to US markets and should witness higher growth.

Looking forward, the underperformance of international stocks this year make it a good opportunity to bring portfolios back to target allocations by trimming winners like larger cap growth companies and adding (as painful as it may seem) to those international laggards. 

Advisory services offered through APG Capital Asset Management, a Member of Advisory Services Network, LLC.

Phone: 713-446-3233  Website: www.apgcap.com

All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.  The information and material contained herein is of a general nature and is intended for educational purposes only.  This material does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.  The future performance of an investment or strategy cannot be deduced from past performance.  As with any investment or investment strategy, the outcome depends upon many factors including: investment objectives, income, net worth, tax bracket, risk tolerance, as well as economic and market factors.  All economic and performance data is historical and not indicative of future results.  All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.

[i] http://performance.morningstar.com/funds/etf/total-returns.action?t=SPY&region=USA&culture=en_US

[ii] http://performance.morningstar.com/funds/etf/total-returns.action?t=IEFA&region=USA&culture=en_US

[iii] http://performance.morningstar.com/funds/etf/total-returns.action?t=IEMG

[iv] http://performance.morningstar.com/funds/etf/total-returns.action?t=AGG

[v] https://www.conference-board.org/data/usforecast.cfm

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