It’s Off to Neverland
We are now almost a year into the rate hike started by the Fed last December and rates, surprisingly, have dropped. The 10-year Treasury was at roughly 2.24% and now sits at 1.55% and mortgage rates have followed suit dropping down to 3.49% from levels higher than 4% back at the end of the 2015. When the Fed met in September, the decision was made to not raise rates, but Janet Yellen kept the carrot out there stating she would expect to see a rate rise before the end of this year. It seems the members of our Federal Reserve have entered a Neverland of sorts. They have joined the ranks of the lost boys in search of the loot, that in the case of the Fed, could get our economy back on a steady trajectory of growth.
Coming Down the Pike
As we turn our lens to the final quarter of the year, two main contenders have taken the stage in our election. Once the battle royal for the office of Presidency is determined in early November, all eyes will turn back to Janet Yellen. Investors will be watching to see if Yellen and her motley crew will maintain the dovish stance of keeping rates low or if they will decide to buck the trend of accommodative policies by their global compadres, and pursue an exit to the Neverland we’ve entered.
One thing is for certain, the markets will remain volatile for the remainder of this year as we make it through these next few months. Looking over the past quarter the markets really didn’t move much over the Summer months. Both July and August brought a relatively range-bound market, not moving more than 1% in a given day until early September, on fears that the Fed would raise rates. For the quarter, the S&P 500 rose 3.3%, the Dow up 2.1%. The foreign markets had it best, up 6.4%, finally turning positive for the year.
What’s Happening Overseas
While the news of the Brexit dominated the headlines surrounding the end of June, the volatility created by the news has calmed down for now. Theresa May, who is the new Prime Minister of Britain, has started the process of working with members of the European Union and recently made a promise to invoke Article 50, before the end of first quarter in 2017. Article 50 of the European Treaty sets the rules and process for the British to formally withdrawal from the EU. As some experts from the Economist note, if Theresa invokes Article 50, the departure from the EU will take the form of a “hard” exit. This means Britain will leave both the customs union and EU’s single-market. These two unions are a form of economic integration between all 27 members within the EU.
Even if members of the EU are willing to negotiate, they will likely maintain their current, tough position, against Britain. If Britain opts to keep its membership of the single-market, which is a deeper integration than a customs union, it must then accept free movement of goods and services from the rest of the EU, and continue paying into the EU budget and observe all current and future single-market regulations without having any say in making them. These negations are far from over and will likely create even more volatility in the markets come the new year and going into the spring of 2017.
What made recent headlines was Germany’s second largest bank, Deutsche Bank. The US Department of Justice (DOJ) is said to be imposing a $14 billion fine against the bank for selling mortgage-backed securities that helped fuel the fire of the last housing crisis back in 2007/ 2008. The main issue here was that the stock has plummeted in value effectively equal to the fine from the DOJ, and Germany’s Chancellor Angela Merkel, has said the country would not come to the aid of the bank. The big unknown is whether or not Deutsche Bank is too big to fail, meaning, if the bank stopped operations, what collateral effect will it have on the global markets. The memory of the financial collapse is still fresh in the minds of investors, which fueled the fear that lead to the volatility we saw during the month of September. Even as we write this newsletter, there is still no agreed settlement between the bank and the DOJ.
Risk and Reward
As we step back and look at US stocks since 2009, the market has essentially trended one direction, upwards. Since the bottom in March 2009, US stocks are now up over 200%. While we have seen some minor corrections in the marketplace, we have yet to see a real market downturn. From a technical perspective, it seems we might be overdue. While we do not believe that equities are overpriced, we also do not believe equities are highly undervalued at these levels. Right now looks to be the right time to reevaluate risk.
Determining your risk comfort zone is important because it helps us design an investment strategy that we can stay the course with. We have migrated to Riskalyze to help us determine your comfort zone. If you have completed a Riskalyze questionnaire, great. If not, we would encourage you to visit our website at www.archvest.com and click on the “What is You Risk Number?” link to take a short dynamic questionnaire. We will be automatically notified of the results and access your comfort zone. While the risk comfort zone is important, it is just one component of helping us determine how appropriate the portfolio allocation is for you.
The other important aspect of risk is your capacity to retain risk. The capacity to retain risk is your ability to hold onto risky assets while being subject to recessionary forces. This one is often under addressed because it is more difficult to quantify. For example, in 2006 someone in the real estate business with high income and high risk tolerance may think it’s alright to be invested aggressively. This strategy would have served them well from 2003 to 2007. However, they have under estimated their exposure to recessionary risk. With the 2008 downturn, this individual would be hit with falling income and portfolio values. They may want to retain the holdings to ride the asset prices back up however, their circumstances may dictate otherwise. Certain professions are more subject to this type of risk than others. Thus, it is important to evaluate this capacity to retain risk and make it part of your overall strategy. As we meet with you, we will be sure to discuss your ability to retain risk and how it may impact your plan.
From the Tax Desk
As we prepare for the start of the 2017 tax season, it’s important to plan accordingly. If your income has changed due to a shift in your career, a bonus, or more company stock has come your way, we should revisit what your tax obligation might be. Of course our goal is to minimize as much tax burden as we can. We plan to connect with you, but please give us a call if any of the above changes have taken place so we can plan for you accordingly.
For those enjoying retirement or who have inherited IRA accounts, we are monitoring the Required Minimum Distributions (RMDs). We will be touching base before the end of this year to ensure all required amounts have been distributed from your account. In addition, from a tax planning perspective, we will also be reviewing the option of Qualified Charitable Distributions (QCD). QCDs satisfy two birds with one stone. First it can satisfy the RMD and because the money goes straight to the charity, it is not included in your income, unlike a traditional RMD. We will be reviewing this and discussing with you as appropriate, making sure we keep in line with your plan and goals.
The Brightside
The markets are picking up again in volatility, but this means opportunities for investors. As we keep in mind your goals and risk comfort, we will be relocating as necessary and putting cash to work. If history has its way, we should see strength in the markets during the final quarter of the year. We remain optimistic but cautious about the economy and will evaluate the data as it comes.
Though our economy is not growing at rapid speed, we are seeing some signs of growth, specifically based off the latest household income study. Median incomes have increased roughly 5.2% over the last year, and more individuals seeking full-time work are attaining it. If incomes can continue to raise steadily, discretionary income should also increase. This will help keep the engine of our economy going, and if incomes rise fast enough, could give the Fed good reason to increase rates again.
We thank you for your continued support and the confidence you have placed in our firm. As always, if you have any questions or concerns please give us a call. Be sure to follow us on Facebook, LinkedIn and Twitter as well as our RSS feed to stay up to date on what we’re reading and thinking.
Eric Lai, John Wenzel, and Kimberly Terry
Eric Lai, John Wenzel, and Kimberly Terry | Archvest Wealth Advisors