Are 2021 Stock Markets As Good As It Gets?

Are 2021 Stock Markets As Good As It Gets?

2021 economic growth may likely be the highest you’ve ever seen.

Consumers, flush with saved cash, are spending freely. We expect GDP growth upwards of 8%; before returning to the anemic 2% we’ve seen over the past decade.  The S&P 500® index built on 2020 recovery gains and finished up 14.4% for the first half, adding 8% over the Spring quarter.  Foreign markets (ACWI ex-US)1 rose 5.5% since March and are up over 10% this year, comparatively subdued by a prolonged COVID crisis in Europe, India, and South America.

Pundits expected the Grand Reopening to generate sequentially improving economic conditions, fostering higher commodity prices, interest rates, and inflation. Recovering employment has accelerated household formation, so home prices and stock markets had nowhere to go but up.  Let’s look to the bond market as another barometer.  Interest rates did not rise near the degree expected. 10-year Treasuries were predicted to sell off and push yields above 2.5% as inflation soared.  Monthly inflation readings are year-over-year, recently causing market jitters. We feel these jumps are transitory, but wage increases are not. So, don’t be unduly concerned that outsized inflation will translate to market declines.  

We are at the high point of global economic recovery. 

We monitor many leading economic indicators as part of our tactical market analysis. The burst of activity as supply chains started healing, manufacturing caught up to demand and goods got delivered all contribute to higher GDP.  Global PMI’s2 are moderating from their highs and the value outperforming growth trend that began in earnest last November is now reversing.  Commodity prices have moderated, input costs are declining, and the inflation scare is easing.  Today, the 10-Yr Treasury Bond is yielding 1.35%, far from reflecting runaway inflation.

Don’t read into this that the economy is weakening or stalling.  Far from it.  This will be the strongest year of GDP growth probably since WWII.  We said earlier that 2021 would be very strong and carry over into early 2022.  Things will revert to the slow growth, relatively low inflation environment that has persisted for many years.  For now, markets are likely to continue grinding higher as corporate profits continue to impress.  The focus now is on the Federal Reserve. 

The Federal Reserve will likely begin winding down its Quantitative Easing program this year.  

They currently buy $80 billion of US Government and agency bonds and $40 billion of mortgage-backed securities every month.  To soften market reaction, they are previewing “tapering” this program, likely ending it over the next 18 months.  How markets react is a primary concern going forward.  This systemic liquidity pushed investors into riskier market segments seeking attractive returns, forcing up valuations across all asset classes.  A scary example is the high-yield (junk bond) market, where yields are now less than CPI for the first time in history!  As excess liquidity leaves the system, we’re concerned that stock and bond prices will fall unless corporate profits continue increasing to justify them.  We expect that justification as profits could increase 30% this year.  2022 may be a different story when the extra liquidity dries up.  While we always have some concerns going forward, recognize that within the major asset classes, stocks are the primary sector for achieving meaningful returns and keeping financial plans on track.  This too will change, but for now, we’re participating as markets go up.

Investor Success may rely on tactical efforts to seek opportunities and returns going forward.  

The US has been greatly outperforming the rest of the world (ACWI ex-US). With a dramatic gap over the past year, it’s now roughly 3:1 over the past 10+ years. This largely comes from big tech stocks representing an ever-larger part of US market values, and the disparity of higher U.S. interest rates vs. developed foreign countries.  Trees do not grow to the sky and trends do not last forever.  This rate differential and our Dollar strength that greatly benefitted US stocks will narrow, pushing the dollar down over the next few years.  Growing federal deficits and equalizing interest rates are both driving factors.  So, foreign stocks will be in favor going forward.  We have been rotating portfolios in this direction, as we expected it already started, pre-COVID.  Now, foreign markets are cheaper, sport both higher growth rates and dividends which we believe are relatively immune from our liquidity decreases.

Secondly, we expect growth and value to take turns outperforming, much as they have the past several months.  This internal market churn will benefit some industry sectors early in the market cycle and others later.  We expect interest rates to gradually move higher, supporting value before economic growth moderates its torrid pace, supporting growth stocks.  Both will follow different paths in a generally upward trend, so it is important to maintain some balance in longer-term strategies.  This is still an active manager’s market, as not all value and not all growth will participate.  

While it may be a bit early, as liquidity is removed from the system credit will be harder to come by.  This will greatly impact so-called Zombie companies who have stayed alive with cheap and/or government financing.  Think of AMC Theaters, Carnival Cruise Lines, Six Flags, airlines, regional banks, and restaurants, etc. As liquidity dries, some companies in these industries will not cheaply refinance debt and their stock prices will suffer.  Passive indexes are full of these stocks, especially in small caps. Roughly 40% of Russell 2000 Index® companies are not profitable now, even with cheap and available credit.  Once the spigot turns, some of these companies will plummet, and the indexes must reflect it. Our style of being tactical within strategies is important. This is especially true in the small, mid-cap, and foreign asset classes where we utilize active fund managers.

Look to stocks of companies paying and growing solid dividends that exceed US Treasury rates.  While many of these companies are household names with strong balance sheets and defensive characteristics, some are not, yet thrive during market upheavals.  Expect the current speculative investment environment to ultimately result in the same fate as all previous ones. When speculative greed ends in regret, investor attention returns to the merits of solid companies. Our Dividend Growth Strategy is built upon this discipline, plus we hold two active funds in our longest-timeframe Growth Strategies devoted to “wide moat” quality companies for this reason.  

While we expect markets to continue grinding higher this year, remember that volatility usually reveals itself when fear is low.  Markets have performed impressively since the COVID bottom and investor complacency is high.  It is normal for markets to experience healthy drawdowns that test the mettle of investor convictions.  On average, the S&P 500® experiences a drawdown of 14% at some point every year.  Some years are much worse and rarely is -14% the stopping point.  We can’t predict a meaningful correction but be mindful that the technical conditions for it are ripe: i.e., speculative investment concentrations, less traditional market liquidity, robotic trading algorithms, and wide bid/ask spreads.  Markets rise like an escalator and fall like an elevator when volatility spikes.  

With the abundance of cash in investor pockets, a correction is likely to once again be short-lived.  Should we see a sharp sell-off, we intend to leverage the opportunity to design another structured note to take advantage of volatility and capture high yields.

Our best guess at this point is the S&P 500 will tack on another 5% – 8% by year-end.  Next year, we hope to see 5% – 8% total, including dividends.  In 2023 we may run into trouble.  Higher interest rates, removal of stimulus, tax increases, and slower economic growth will all pressure stock values.  Since markets are forward-looking, we are focused on how soon to reduce exposures to growth assets.  

For now, pent-up demand will continue driving consumers and corporate revenues. The entire world is more than ready to get outside.  Profits are strong and likely to get stronger.  Corporate and individual balance sheets are healed and in aggregate, perhaps in the best shape ever.  The economic environment is healthy and supporting global growth. At Integras Partners, we replenish retiree immediate spending accounts in up markets, and will likely do it several times this year. 

We provide clients the emotional freedom to live life with less worry about finances and enjoy their favorite activities!  

We’ve got our eyes on the markets, the economy, and politics, so let us worry about the right moves for you.

Contact us to learn more.

The Science of Investing

Markets Have Already Priced-In the Economic Recovery

Markets Have Already Priced-In the Economic Recovery

With vaccinations leading to herd immunity, the US economy continues to blast out of its record-setting 2020 contraction.

Economic data continues to confirm what financial markets anticipated months ago: Not since the early 1980s have we experienced an economic resurgence like the one ahead of us, but it likely will not be a long ride.

Gross Domestic Product (GDP) growth this year should be somewhere between 7%-8% with some carryover into 2022 falling in the 4%-5% range. Then we expect to settle back into the 2%-3% range going forward.

Driving this growth will be a record $19.5 Trillion in consumer savings. Unemployment bonuses, stimulus checks, and limited spending contributed to a $4 Trillion increase last year! (M2 measured by Federal Reserve) We expect a good chunk of this to be unleashed on travel, restaurants, concerts, sporting events, and everything else we are longing to do. It will lead to dramatic employment gains across the wage spectrum, further sustaining the recovery itself.

Financial markets are forward-looking and have priced in much of this over the past six months. Making this repricing so close to “full” is all this cash in the system (with the Fed holding rates close to 0% and sustaining corporate and municipal bond purchases) forcing money into stocks and elevating prices. The Fed has gone far out of its way to articulate this strategy and will continue until employment and inflation show more durable and sustained levels. Financial markets have responded, and not just stocks and bonds. Everything from housing to collectibles to cryptocurrencies has been bid up in price due to this incredible amount of money in personal bank accounts earning close to zero while losing value to inflation.

The S&P 500 Index® is currently valued at 23 times NEXT YEAR’S expected earnings. While earnings estimates may revise further upward, this is a rich valuation vs. the long-term average of 16 times. This combined with investor enthusiasm has historically been a reliable indicator that markets have gotten ahead of themselves and are vulnerable to a correction.

Over the next 12 months, we expect to see rates on 10-year Treasuries exceed 2.5%. Should that occur and the S&P 500 achieve their 2022 estimate $200/share earnings, stocks today are still slightly overvalued. Further market gains can only come from unexpected earnings growth or investors throwing caution to the wind and driving prices even further. It’s possible that both will occur given the sheer amount of cash seeking a positive return. But, at some point, both will stop. Given the expectation for increased corporate taxes, higher earnings may be harder to achieve, and consumers may feel less confident. Soon, higher corporate borrowing costs due to rising rates will also impair earnings growth.

The Fed wants to see more permanent inflation (i.e., higher wages), unemployment levels come down, and benefit a broader demographic (i.e., close the employment gap). The pandemic has disproportionately impacted minorities and working mothers, and once schools re-open and subsidies stop, they will re-enter. Until these and broader data points indicate durability, the Fed will allow the economy to run hotter than normal before putting the brakes on. This means both higher inflation and higher long-term interest rates.

A positive return will be almost impossible in bonds – absent a severe stock decline. 20-year Treasuries have declined over 20% since their August high due solely to rising interest rates. There will be more losses to come as the recovery continues and the Fed allows inflation. Therefore, generating safe income requires a different definition of what constitutes safe. Yes, you could accept the assurance of a 1.5% yield from a 20-year T-bond, but you must also accept the certainty that it will lose principal value in the face of rising interest rates. Generating income has become increasingly uncertain as to the only options for yield place principal at greater and greater risk. So, we designed custom Structured Notes for our strategies last year and are attempting to do so again now. These are not without risk, but we get to define the parameters.

Mark our words, the instant the Fed hints at reducing its accommodative policies, financial markets will react harshly. Asset values built upon the assumption of sustained easy money will fall. We don’t know when that will be, but we remain vigilant to leading indicators. If companies succeed in passing rising input costs through to consumers and generating unexpected earnings growth, markets will continue grinding higher. If not, then we are set up for a significant correction. No one can know how this will turn out.

The Traditional 60/40 Allocation Model may not help. Millions of investors rely on static allocation strategies because their advisors recommend it. This concept relies on bonds generating reasonable income and appreciating in down markets to even out stock volatility. Neither of these is likely in the foreseeable future, given current interest rates and inflation pressures on bond values.

Integras Partners’ layered risk investment strategies will once again prove invaluable in navigating these next few years as markets gyrate from fear to euphoria and cycle through again. Our paradigm allows the peace to enjoy today while keeping long-term assets invested for future growth. Separating conservative assets to provide several years’ cash flows insulates most of your money for growth, providing the time needed to ride out market cycles and achieve desired returns.

We are also tactical beyond being strategic. There is a better than even chance that equity markets continue grinding higher this year in the absence of bad news. Our strategies are currently overweighted to materials, industrials, consumer discretionary, and the financial sectors. We are content keeping our current equity exposures as the first wave of quarterly earnings reports have greatly exceeded estimates. We complete our planning discipline by cascading outsized gains into more conservative strategies to sustain income, dictated by each client’s custom income needs. For other illiquid assets – such as houses, cars, collectibles, etc. – if you are pretty sure you won’t want it a few years from now this is a great time to be a seller.

While we do feel rather positive about the remainder of this year into 2022, our fiduciary responsibilities keep us grounded in understanding risks to investor capital. Please recognize that while the economy will keep humming, the market already has.

So, as we flow money in our client’s shorter-term spending accounts, we encourage them to freely spend it!

If you’re interested in learning more give us a call at (404) 941-2800, or reach out to us about your situation

Click here to access our latest e-book Strategies for Successful Individuals.

Good Riddance 2020!

Good Riddance 2020!

Our hearts reach out to all of you touched by the tragedy and financial impact of the pandemic.  

US stock markets performed remarkably in the face of an historic global catastrophe.  Swift and bold action by the Federal Reserve (with lessons learned during the Great Financial Crisis) buoyed financial markets in the face of what could have been a disastrous year on the investing front as well.  With US stocks down 30% in March, no one would have believed that the S&P 500 Index® could finish the year up 18%.  Other markets and indices significantly rebounded as well. The EAFE (foreign) index ended up 7% while the MSCI Emerging Markets Index rose gained 18% and the Russell 2000 (small cap) Index added 7%.  

In March and April, when fear was highest and markets lowest, we explained the stock market collapse was not reflecting economic or market dynamics, but was “event-driven”, and therefore temporary.  Almost all our clients stayed invested and were rewarded.  Our Time-Horizon Strategies, which minimize short-term impacts by keeping investment appropriate to needs, provides greater peace to weather sell-offs and even spend comfortably in retirement with less worry about portfolio values.

As we enter 2021, financial markets are projecting that life will return to normal later this year.  We agree, seeing enormous pent-up demand for discretionary spending.  Bank savings (measured by the Fed as “M2 money supply” has increased some $4 Trillion since March.  Markets anticipate that much of this cash will funnel into the economy, leading to an economic boom once vaccines are taken and the viral spread tapers off.  Economists we respect are projecting 5% GDP growth for both this year and next.

Markets are forward-looking and have already “priced-in” these expectations. Given the economic backdrop and rising COVID cases, the momentum of the market’s trajectory is both remarkable and concerning.  There is good reason for optimism, but some areas of the market are outright euphoric.  Speculation is high and IPO’s, Special Purpose Acquisition Companies (SPACs), and segments tied to genomics, renewable energy, tech innovation, etc. are ridiculously valued as investors chase sky-high prices. Investor sentiment is high while valuations are elevated, which is not ideal.  An unforeseen event could ignite a significant correction amplified by evaporating optimism.  This is not a forecast but a valid concern for near-term risk.  We advocate keeping cash to meet anticipated expenses for six months or so.

Bonds are no longer the income producing assets they once were.  With economic recovery in progress, interest rates are rising, and bond prices are falling.  In August, the yield on the 10-year Treasury Note fell to an all-time low of 0.52% as investors feared a second virus wave.  Today the yield is double. As the rebound continues inflation will come with it.  Over the year, rates will likely return to what we saw a couple of years ago, 1.5%-2%, consistent with inflation.  We will have a few months this year where inflation readings come in significantly higher compared to 2020 and the financial press will extrapolate it into an impending inflationary spiral.  We don’t see inflation becoming unmanageable given what we see farther down the road.  The only value of bonds now is to moderate downside portfolio risk, which is important to many investors.  

When appropriate, we will utilize structured notes and private real estate in pursuit of meaningful income in our strategies.  These are less-liquid vehicles, which we’ll be happy to discuss with you.  While our use of them is measured, they can be great complements to stocks to achieve long-term client objectives while core bond returns are expected to hover near zero for years to come.

There are several issues we will closely monitor going forward. Markets are anticipating an explosive “recovery” in spending that should make 2021 an outsized year of GDP growth. We remain vigilant and focused on ‘what’s next?’.  What happens when tomorrow’s good news is behind us?   When government stimulus is no longer needed, and liquidity injections slow down?  When investors see all the good news fully priced into asset values, what lies ahead is a rockier landscape.

Optimistic sentiment is being rewarded in today’s markets based on good news yet to come. This is our primary concern for 2021.  To avoid a meaningful market decline, it is imperative that companies generate the earnings needed to justify today’s rich valuations.  Any significant shortfall and a correction are likely.  While downside volatility is always unsettling, we strongly believe the second half of 2021 ensures a profitable year for equity investors. 

Secondly, we’ll monitor whether enough inflation stays in the system to keep “value” stocks outpacing the “growth” segment.  The long-awaited value resurgence has just begun and has lots of hurdles to match the long run growth enjoyed contrasted to value. If we resume the “low growth” economic environment of the recent past (our base case), value may not have the tailwind necessary to continue its resurgence and we will adjust the sails on portfolio allocations once again.

Third, will foreign markets close the performance gap of the last decade vs. US stocks?  We have written previously that international stocks are comparatively cheaper, have higher growth rates, with higher dividends to boot.  We believe the US dollar is likely to continue to trend lower vs. foreign currencies, which will provide additional fuel for outperformance. Given these factors, we expect to increase our international exposures further during the year.  For longest-term (usually retirement) accounts, we also employ Dimensional Funds which you may not be familiar with as they have limited access.  They are very low expense, pension-style funds oriented to small cap and international exposures and managed by market economists, including several Nobel Laureates.  They tend to do very well in up markets.

The last issue of concern is how government policy will impact economic growth.  The political landscape has changed and so will tax policy and regulation.  We don’t expect significant tax increases this year as we put an end to the virus, get economic growth back on track and getting those displaced back to work.  We have exploded the federal deficit and in 2022 raising taxes will be a larger conversation in Congress.  Regulations will tighten around the edges this year but in 2022-23, will likely lower profitability and growth for some sectors and benefit others.  We expect a modest corporate tax increase. After a sharp decline from 35% to 22%, it will likely come back towards 25%.  Income taxes for those earning over $400K are also likely to increase. Much remains unquantifiable at this point. When all the good news is in the rearview, bad news is all the market can see.  So, we may need to respond and back off risk late this year or into 2022.

But in 2021 we our clients to party like it’s 1999!  We say go for it!  We keep a close eye on exposure to risk assets, as we know that at some point, we will have to seek safer shores for expected gains. We look forward to resuming normal life this year and want you to feel secure in doing so We invite you to schedule a call to discuss your situation, so you can go live life, because we’ve got your back!

Learn more what Sidney and Keith are saying about 2021 investing strategies. Sign up to receive Integras Insights delivered to your inbox.

If you’re interested in learning more give us a call at (404) 941-2800, or reach out to us about your situation

Focused on Recovery

Focused on Recovery

With investors focused on the recovery theme, July and August were very good months for financial markets.  So good in fact, they became so extended that stocks sold off somewhat during September. Markets should continue their upward trajectory fueled by near-zero interest rates, further economic stimulus, and operating efficiencies as companies better generate growth in this constrained environment.  Operational efficiencies and work from home will remain prevalent as most companies discover ways to operate with less overhead.  It could take years for employment levels to recover.  

At quarter-end the large cap S&P 500 Index® was up 5.5% for the year while small caps (Russell 2000) are down 9%.  Even foreign markets (All Country World Index – ex US) are within 5% of breakeven for the year. China is the clear leader, up 16% with emerging markets down only 1%.  All virtually unthinkable just six months ago.  We do think small caps have some catching up to do.

Not all sectors and industries have participated in this advance.  While technology remains the clear leader year-to-date, extended valuations led us and others to reduce exposure and rotate toward industries more dependent upon an end to the pandemic.  These “value” sectors (industrials, utilities, financials, and energy) represent a less expensive way to be invested for the coming earnings and growth recovery.  While these sectors offer lower downside risk, they require the economic growth the market expects to for them to appreciate.  

It is well known the market hates near-term uncertainty.  The primary concerns are the election and timing of further economic stimulus.  Election uncertainty was primarily centered around a contested election requiring the involvement of the courts.  As polling has unfolded over the past several weeks, the market sees an ugly decision process that is less likely and has advanced in response.  Also, the timing of further economic stimulus becomes more certain without a contested election.  The only question remaining is how much.  But both major uncertainties are being alleviated in the eyes of the market today.

We certainly do not pretend to know the ultimate outcome of either.  One thing we do know is that elections typically produce much more emotional upheaval than financial disruption.  It is vitally important not to let political emotions derail your investment strategy.  We have experienced multiple election cycles with similarly forecasted dire consequences.  Yet through it all, financial markets usually advance regardless of who wins. Ultimately it is corporate earnings and economic growth that determine investment performance, and both have shown their ability to adapt, whichever party is in power.

On a longer-term basis, our concerns are in economic growth, inflation, and stock valuations.  It will likely be 2022 before GDP returns to pre-virus levels and will be rather lumpy, as states and countries reopen in different ways.  This is generally what drives the disparity of market sectors.  Those able to generate revenue trade at a premium to those more dependent on full recovery.  This is also why we need both in a portfolio – one for growth albeit at higher price risk, and one for future growth with less downside risk today.

Stimulus from the CARES Act earlier this year put real money in the hands of real people – very different than the stimulus of the 2008 Financial Crisis.  It added $3.5 trillion of new debt to our existing debt while adding roughly $2 trillion to the money in circulation. Normally adding this much money into people’s pockets would spark a spending spree and prices would increase accordingly to soak up the additional demand.  What happened instead is that recipients saved it; the personal savings rate immediately skyrocketed from 7% to over 30%.  Much of it has been spent by now, by those who needed cash to get by and others who used the extra cash to spend.  Should new stimulus coincide with a vaccine or treatment allowing businesses to fully reopen, inflation should result.  The money supply will be much larger, economic growth will strengthen and those working will feel more confident to spend.  

We have written before how difficult and risky it is becoming to produce income.  Inflation undermines the value of low/no-growth assets and bonds are the ultimate no-growth asset.  With interest rates at all-time lows, bonds are priced very high.  As inflation causes interest rates to rise, bonds lose value, which we are already witnessing.  That is one reason we continue custom designing structured notes to generate much higher income with a very different risk profile.  Bonds will always serve a purpose in a portfolio, but income won’t be primary for a long time.

Lastly, we’re concerned over the risks of heightened stock valuations.  The S&P 500 is currently valued at 25 times next year’s expected earnings, far above the historical average of 16 times earnings.  Extended valuations typicallylead to deep corrections.  However, we could see a rotation among the S&P 500 sectors, where the expensive technology and communications stocks fall in favor of the cheaper industrial, materials and financial names.  With the amount of stimulus in play and investors seeking a place to put cash to work, this seems a more likely outcome.  

How quickly can global economic growth resume to support further price appreciation?  Valuations this high require either substantial earnings growth or investors paying ever higher prices for lackluster earnings.  As the latter is unlikely, expect modest returns for a while – especially without the tailwind of falling interest rates. When all the good news is priced in, a correction could follow without global economic recovery.

Where will future growth likely come from?  The US markets have far outpaced foreign counterparts over the past decade.  Technology is a larger part of our economy and we are still viewed as the safest place to invest.  But our markets are expensive, and our economic growth is lower than other parts of the world.  We have written about global demographics supporting higher economic growth in the emerging markets.  Their growth is and will be higher than ours going forward, and foreign markets are less expensive and have higher dividend yields.  It comes with the tradeoff of greater volatility, so having too much can be counterproductive.  We have maintained emerging markets exposure for the past few years and anticipate increasing it as the global recovery matures and domestic growth is harder to come by.

Today the market is driven by the recovery from COVID and reopening the economy.  Later will be a different story.  While it is very difficult to predict market timing, we remain diligent to our clients’ long-term objectives and risks they face in creating the life they each want.

If you’re interested in learning more give us a call at (404) 941-2800, or reach out to us about your situation

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2020:  The Year of Extremes

2020: The Year of Extremes

This year has been epic in its trials and tribulations and we would all like for it to be over.  We empathize with you, as the longer this continues the more frustrated we become. This too shall pass and hopefully we learn things about ourselves that improves our lives. In the meantime, we hope that you and your loved ones remain healthy, safe and sane.

Within just five months we witnessed the fastest market decline in history, prompting the quickest recession and followed by the fastest recovery.  Yet while baffling many investors, the S&P 500 Index® finished the first half of 2020 only 3% below where it started.  We acknowledge that stock markets are “forward-looking” but given the headlines it’s hard to imagine that we’re close to full economic recovery – though we have seen the low point.  We are also somewhat surprised at the resilience of the major averages given that recovery is going to take far longer than we envisioned when this began.Investors are placing their faith in a vaccine becoming available sometime early next year and economic activity resuming its pre-pandemic pace in short order.  While we hope to see a vaccine this winter, pricing in a near-complete recovery is aggressive.  We believe economic growth will continue improving but a full recovery will prove choppy, slow and extended.

With markets back to pre-crisis levels, there are concerning circumstances and trends emerging or becoming exacerbated.

We have written how growth stocks (technology, telecom, pharma) are outperforming value stocks (financials, energy, materials).  The differential over the last decade was already wide and over the first half of 2020 it added another 24% – growth is up 12%; value is down 12%.  If we look at technology vs. everything else, tech stocks are up 18% for the year; everything else is down 9%.  We know that at some point this will correct and no one knows when. But we’ve all seen this movie before.  It debuted in March of 2000 and robbed years of retirement from those who abandoned value to chase growth.

The market has become highly concentrated in just a few big names – Amazon, Microsoft, Facebook, Apple and Netflix primarily.  There are sound reasons why these companies are attractive, yet at some point valuations will matter.  The forward Price-to-Earnings ratio of the S&P 500 is now at 25x; the highest since 1998.  While valuation is not a timing mechanism, we must remember that trees do not grow to the sky.  These excesses are typically cured by the top coming down and not the bottom coming up, so while we continue to overweight the leaders, we are keeping our eyes wide open.

Only the technology, communications and consumer discretionary sectors have posted positive returns for the year.  If the April/May period is repeated, we will see the value spectrum come back to life.  This will only occur when new COVID cases are in retreat – which the S&P 500 has been foreshadowing lately.  It has remarkably led new case counts by about three weeks and is forecasting now that case counts should begin retreating again.  Only a vaccine will enable a full economic recovery, but the market has faith that one is near.The Treasury and Federal Reserve heaping stimulus packages upon the economy are the primary reason that markets continue to perform well.  As we outlined in our Q1 commentary , the Fed has successfully so far levitated the economy while the pandemic plays out.  That lifecycle is proving longer than anticipated and with enhanced unemployment benefits expiring next week, there is growing concern that consumer spending may retreat, rents and mortgages may not all get paid and the market will have overplayed its hand.  Therefore, all eyes are on the continued supply of cash via further stimulus plans until an actual economic recovery can occur.  This being an election year, expect further stimulus to sustain this rally.

We have longer-term concerns about all this new money entering the financial system.  M2 money supply is 21% higher for the year – an increase of $4 trillion just in the US.  Normally so much cash in the system would be quite inflationary.  This time, because of slower spending, it’s the dollar retreating relative to foreign currencies.  We anticipated this and used profits harvested during June to establish a position in gold.  So far, this tactical move is paying off quite well and when a vaccine becomes available and economic growth accelerates, expect inflation and gold to accelerate, too.  Another beneficiary is our foreign equity exposure which we expect to outperform the US markets over the coming decade.While this is a confusing time, one thing has been proven during the pandemic.  Our paradigm of Goal Horizon Investing  has allowed our clients to remain focused on living life (such as it is these days), as short-term income is insulated from market gyrations. We have also capitalized on opportunities presented by fear just a few short months ago.  

We cannot be perfect with timing, with our investment choices or in our vision of how things will unfold.  But we don’t have to be perfect when clients’ investment allocations to risk are dictated by their future withdrawal needs.  It is a safety mechanism we purposefully engineered years ago and continues to prove its value. 

We have a difficult task making long-term investment decisions with so many unknowns about the pandemic’s resolutionbut our paradigm ensures the longer timeframes needed for growth investments to succeed.

We are also faced with generating relatively safe income when interest rates are at yet another all-time low.  While Treasury securities yield less than 1% the only way to produce a livable income is to take additional risk.  This means accepting price volatility to obtain desired incomes.  Our Income Strategy is our current laggard, as two debt positions experienced just such price volatility while continuing to produce attractive income.  Prices will recover in a more durable economy, but it’s a prime example of how difficult it is to generate a comfortable income these days.  We did use the dislocated pricing during March and April to build customized Structured Notes producing very significant income.  Be sure to read about our Structured Note holdings, generating outsized income while interest rates remain near zero.  Please stay safe and follow medical guidelines.  We will come out the other side of this in better shape than we all thought possible in March.


If you’re interested in learning more, reach out to us about your situation.  

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Headwinds Become Tailwinds

Headwinds Become Tailwinds

Financial markets entered the 4th quarter with heightened concerns that a recession was near. Three primary concerns stood to determine whether markets would rebound or safety should be the preferred path. During the summer we installed hedges in our longest Time Horizon Strategies as our concerns were high as well.

Thankfully, we received a raft of good news over the past three months, taking markets to record highs:

  • The Federal Reserve signaled it would not raise interest rates, perhaps for all of 2020.
  • The Trump administration achieved a “Phase One” deal with China.
  • Brexit uncertainty was decided with the landslide re-election of British PM Boris Johnson.
  • The US dollar peaked and has begun falling, which benefits trade with our major partners.


These all buoyed investor sentiment, turning markets from recession watch and to rally mode. Summer headwinds became tailwinds in the Fall. This news is cited most often as fueling the market’s resurgence but the real catalyst pushing markets is the renewal of Quantitative Easing (QE) by the Federal Reserve.


The S&P 500 rose 8.5% in the final quarter, capping an astounding 31% for the year. International markets rose 7.3% for the quarter and 22% for the year. Emerging markets broke out, gaining 11% during the quarter and 17% for the year. Bond markets were relatively flat this Fall but were up 8% on the year as the Fed lowered interest rates three times earlier in the year.
Accordingly, we sold most of our hedges and again returned to a fully invested profile with confirmation that the headwinds of Q3 were indeed in the rear-view mirror.

The Real Catalyst 

You won’t hear it called Quantitative Easing by the Fed itself, given the unpopularity of the term. But make no mistake, QE it is. During the quarter the Fed purchased about $300 billion of debt securities to build reserves for an arcane part of the financial plumbing that allows financial markets to function – the REPO market.

This reason for further balance sheet expansion is frankly less important its effect on financial markets. Every time the Fed’s balance sheet expands the markets rise. Every time it is reduced, markets fall. Should the Fed again pare its balance sheet, markets will surely fall again. QE does the same thing as lowering interest rates, printing money or expanding the monetary supply – allowing the dollar to fall and asset valuations to rise. Since it has consistently worked and there is little room to further reduce rates, we can assume this is the playbook of the future for central banks. Until it creates meaningful inflation or unforeseen problems with market functions it will continue. While it continues financial markets have a tailwind.

When inflation or undervalued commodities begin a long-expected surge a fierce headwind for financial markets will return. In the meantime, we will gladly participate in the growth and give credit to the Fed for sustaining the stock market rally.

What’s in store for 2020?


During 2020, equity markets will face many risks: constricted trade impact, tepid domestic growth, rising payroll costs, corporate margin pressures, modest earnings, and the 2020 election. Given the markets’ recent rise, full to high valuations move to the top of this list. We have written about all of these and they will drive markets. Because of emotions, it will be the electoral process that will get the headlines.

Capitalism has become the foil for the more “progressive” Democratic candidates. As their poll numbers move, equity markets will correspondingly move in the opposite direction. As we approach the Democratic convention this will become more exaggerated and pronounced should one of them be nominated. We continue evaluating market risks and opportunities but do expect volatility to rise as we get closer.


On a fundamental level, it is earnings and valuations that determine market direction. Prices have exploded higher as investors recently piled into all types of risk assets. One year ago, the S&P 500 was priced at 14 times earnings. Today it is near 20 times. Historically, when markets reach into the 20’s on a price/earnings basis, trouble usually isn’t far behind. But timing markets based on valuations is one of the worst methods to manage market risk. With low-interest rates and QE remaining in place, it’s possible that the increasing valuation trend could continue for a while.

Earnings estimates came down over the past several months as the economy slowed and corporate leaders became less optimistic. Given this reversal of headwinds, we could see an improvement in earnings to start the year. While a positive development, the possibility of a correction should not be dismissed. However, a reset of stock valuations will not likely end the bull market.


Lesser-Known Risk


The Fed stated in December that it would allow inflation to overshoot its 2% target before it considers raising interest rates. One of the goals of the previous decade’s massive QE programs paired with historically low rates was to ignite dormant inflation. While there is little evidence that inflation is poised to hurdle the 2% threshold, the stage is set for it. Tight labor markets, significant wage growth, constrained inventories and supply chain disruptions have all created dry powder for inflation to rise. But it needs a catalyst to set off the chain reaction.

We don’t know which catalyst it might be (a known unknown). Yet should inflation take off, the Fed will be forced to act and put the brakes on the economy. This will surely lead to a significant market decline, perhaps ending the great bull market. While it’s inevitable, we will stay fully invested and vigilant for signs.

Going Forward


With the dollar weakening, a potentially strengthening global economy and the significant valuation discounts of foreign stocks, we are at the precipice where foreign stocks could outperform U.S. stocks. While this condition has previously been undermined by trade tensions, there is an opportunity in foreign markets. Emerging markets hold greater promise as their performance gap to US markets has widened over the past decade. Therefore we increased foreign and emerging market exposure over the past quarter. Should our dollar continue to fall, clients will enjoy an additional tailwind here.

Our Cash Flow Timeline Allocation Process dictates client exposure to market risks, based on how long progressive amounts of money can remain invested. We make sure each client has adequate resources in less volatile strategies to leave long-term money invested to outlast risks facing market assets. We have also been busy recently performing due diligence on a range of alternative Real Assets to complement market risks while seeking attractive returns. We will explore increasing exposure in this area – on a case-by-case process.

As we enter 2020 we do so with less than 20-20 vision. We remain mindful of the risks we know and ever vigilant for signs of those we don’t. For now, the sun is shining on financial markets, but we believe the upside is limited given the longevity of the economic cycle and risks inherent to high valuations. While we remain fully invested we seek opportunities to reduce risk while sustaining attractive returns. Readers should expect episodic volatility as news events the interest rate landscape unfolds. Our clients can rest assured that their assets are in line with their income timelines and that Integras Partners works diligently to moderate market risks when uncertainty is high.


If you’re interested in learning more, reach out to us about your situation.