Background and Overview
As we suspected early in the year, this has been a volatile period for the domestic and international stock markets. This is in stark contrast to the placid U.S. market in 2014 that may have given everyone a false sense of security. Actually the feelings of market invincibility started even earlier than 2014; it started with the flow of money into our monetary system ever since the Federal Reserve began its process of quantitative easing.
Let’s go back a few years and look at the direction of the stock market as measured by the S&P 500. Other than one glitch toward the end of 2014, the market’s trajectory since the beginning of 2012 to the end of 2014 was ascending skyward as if gravity didn’t exist. If it were not for the memory of the market debacle of 2008, this would certainly have become a three-year period that would easily foster complacency.
We know, however, that this period was a historic anomaly fueled by the Federal Reserve’s policies. These policies were meant to bring us out of the Great Recession and stimulate the economy. Judging by this stock market chart and its resulting effect on growing personal wealth, they were successful. But everyone knew that this bubble would come to an end. As this cartoon shows, everyone knew that the tide can’t make all boats rise forever.
If we have gotten desensitized to stock market volatility, 2015 has brought us back to reality. This is NOT a bad thing. Healthy markets, markets that are operating normally, will have ebbs and flows – more like a tide that has both high tides and low tides. That’s normal.
With the Federal Reserve having ended quantitative easing, and with the prospect of “normalizing” interest rates, the Fed would like to be telling us that we are on the road back to a normal economy. When they are comfortable in raising interest rates it will be because they see jobs steadily increasing and most of the indicators they track looking healthy. They would like to be giving us confidence in that assessment.
We at Silver Oak are going to do our best impression of Missouri – they will have to show us. We don’t doubt that the economy is improving. But we are also aware that this grand experiment in artificial economic stimulation has never been done before. Therefore, unwinding it also has never been done before. The Fed is a little like a magician who practices an act of magic – and keeps practicing at it until she has mastered it. We expect there will be some glitches along the way.
A look at 2014
From Chart 1, above, it is evident that 2015 did not continue the same trajectory of the last few years. It may be instructional to recreate that chart, except we will only look at 2015.
Even before the drop in August, we can easily see that the market exhibited significant price swings between January and the end of the second quarter in June. In fact, the level of the S&P 500 at the beginning of the year was virtually identical to its level at June 30. However with dividends included, the total return of the S&P 500 through June was 1.23%. Yet it was hardly a straight line from 1/1/15 to 6/30/15. The gyrations were caused by any number of headline-grabbing news reports, not the least of which was the speculation into the timing of an interest rate increase by the Fed.
The graph of the period after June provides an equally compelling view of the markets. As the next graph shows, a significant market correction started in August. At its low on August 21st, this index lost almost 9% from the beginning of the year. Fortunately, in the week since then, the market has rebounded nicely, but is still in negative territory for the year. As of the end of August when this newsletter is being written, the market had lost about -4.2% for the year and -2.825% including dividends for the period..
Commentary and Outlook
On the one hand, we view this market correction as a normal part of traditional market cycles. Yet there are still a number of peripheral forces at work that give us some pause. These other forces are like a hangover: they are the result of an excessive policy. Until the policies that have been implemented since 2008 work their way out of our monetary system, we expect there will be any number of sobering moments.
No one in the investment world can tell you with confidence that the market will move higher or lower in the short run. And that includes every pundit on CNBC or MSNBC or any other show. We believe that trying to time the markets has proven to be an unsuccessful strategy over a long period of time.
We prefer to work closely with our clients to establish an investment policy that is built for the next 3-5 years, if not longer. We have demonstrated that by utilizing our approach to asset allocation that focuses on the risk level in the portfolio, we can minimize the downward pressure on portfolios. Of course, to the extent we have any money in the stock markets, we cannot be 100% insulated.
Behavioral finance teaches us that the biggest reason individual investors fail to reach their goals is due to emotion-driven decisions. Therefore, we have worked hard to take that element out of consideration. Your portfolios purposely contain a reduced level of exposure to these market gyrations. We are confident that you have noticed that; that’s why we had virtually no panicky calls from clients in August.
However, we are always striving to do better. While our portfolios held up nicely, we expect to see improvement during the remainder of 2015. Our Lower Risk Bucket has historically provided stability and cash flow. This year, however, we experienced a decline in one of the American Realty products, BDCA. We wrote to you earlier in the year to communicate about this. We have heard from that company that they have begun the process to list their shares on the open market. When that happens, we are hopeful that the share price will rise to approximately the price our clients paid for the investment. We would be fine with that since we primarily bought this investment for the 8% cash flow. Our goal will be to sell these shares after it is listed on a stock exchange.
Other than that, our Lower Risk Bucket is performing very well. We have a number of different investments in that Bucket that are producing from 5-8% annual income, some of that tax sheltered until a public listing and sale occurs. We believe more than one of those investments may also be listed for sale this year. If that occurs, we will decide whether to continue to hold each investment, or sell it. At that time, we will also be looking into other sources of stable investments with good cash flow.
Once again, we at Silver Oak will always welcome your phone calls if you have any questions or concerns about your portfolio. The rest of the year is likely to continue being volatile, and we want to make sure that you know we are here for you. We have earned your trust and we will always strive to keep it.
Warmly, Your Investment Committee,
Joel Framson, Eric Bruck, & Linda Cao
This Newsletter covers the Quarter ending June 30, and subsequent events through August 31st.