In the 3rd Quarter, the tide turned severely for markets. The global stock market declined 18% for the Quarter, ending the quarter down 14% for the year. September in particular was a month in which investors capitulated. Gold, the darling of all investments this year, declined 11% in September. Non-U.S. stocks dropped by more than 10% in September. Emerging market bonds, issued by countries that are growing, declined 9% for the month, and global REIT stocks dropped 11%. Even U.S. corporate bonds, despite healthy U.S. corporate balance sheets, declined in September. The only assets that had positive earnings in September were U.S. Treasury bonds and municipal bonds.
For some time, we have leaned away from stocks in favor of lower volatility investments. Despite the temptation, we are not selling assets and raising cash levels in the portfolios. Markets in September experienced the same kind of nondiscriminatory selloff that occurred in late 2008 and early 2009, and again in the 2nd Quarter of 2010. Going into October, we have seen glimpses of a market uptick. If we’ve learned anything from previous experiences, we have learned that this is not the time to panic and abandon underperforming assets that are part of a thoughtful investment approach.
Supporting our “we won’t sell” position is research regarding investor confidence from Ned Davis. The research shows that when investor confidence reaches an extremely pessimistic level, and investors raise cash beyond certain levels, it is statistically likely that markets will improve. Recent measurements show that investor confidence is, in fact, extremely low and is approaching 2008-2009 levels. The VIX, or the investor “fear” index, is also spiking to levels where strong market returns have historically followed. Given this data, we are not planning to raise cash levels in the portfolios.
While we are not selling, we note that our conservative portfolios are designed to limit losses. Our basic structure is to have fewer stocks in our portfolios than most investment advisors. We believe this is necessary to limit volatility and build wealth steadily. Our aggressive portfolios are less than 50% stocks, and our more conservative portfolios are 15-22% stocks. We reduced our allocation to stocks in the fall of 2010, and reduced exposure to European stock in many portfolios in early September prior to the most recent selloff. Earlier this year, we also added the Steelpath MLP strategy as a stock substitute, and this fund is holding steady and outperforming stocks. In the recent downturn, our limited allocation to stocks has benefitted the portfolios, and the portfolios have outperformed the S&P 500 and S&P Global stock indices.
In addition to owning limited amounts of stock, another method to reduce losses is to own hedged investments. Over 20% of our portfolios are allocated to hedged investments instead of stocks. Over time, these investments are designed to earn more than bonds without the volatility of the stock market. In a down market, we expect this asset class to hold its value, and our hedged investments have generally done so through the 3rd Quarter. A good example of this is the Absolute Strategies fund, which is up 2.2% YTD through September 30th.
Municipal bonds are a significant piece of our taxable accounts, and our municipal bonds have performed strongly this year, earning 6-7% for the 9 month period. We see municipal bonds as a solid anchor in the portfolio. Keep in mind, though, that the bonds themselves are yielding in the 3% range, and the 6-7% return reflects appreciation in the price of the bonds. We don’t think continued appreciation in municipal bond prices is likely to continue.
When we invest in taxable bonds, we face the eternal choice of buying U.S. Treasury bonds, U.S. corporate bonds, and non U.S. government and corporate bonds. Recently, we wrote our clients to discuss the S&P downgrade of U.S. Treasury bonds, and the historically low yields that these bonds offer to investors. We have also written about the attractive yields and strong balance sheets that U.S. corporate bonds can provide, and the higher yield and dollar hedge that emerging market bonds can provide. And finally, we have favored the idea of trading bonds opportunistically, using both long and short strategies to increase return. As we typically do, we have invested in all of these types of fixed income funds. Ironically, the only taxable bond strategy that is working currently is U.S. Treasury bonds – the same bonds that received the famous downgrade from S&P. Treasuries still represent the safest investment, and investors flocked to safety in the 3rd Quarter.
While taxable bonds, other than Treasury bonds, are not working as well as expected to limit losses, we are not abandoning these funds. The yields at current prices on these strategies range from 4-8%, and we have a high level of conviction in the ability of these bonds to mature rather than default. Corporations in the U.S. have high profits and high levels of cash. At the same time, Treasury bonds offer 2% yields with little potential to appreciate further, and are likely overpriced.
To summarize, our economic forecast is very low growth. High public debt in developed countries, downward global GDP forecasts, a poor housing market, high unemployment and uninspiring actions from the U.S. and European governments all contribute to a flat growth forecast. Particularly in Europe, until policymakers give us clarity around the re-structure of Greek debt, we think it will be difficult for markets to improve dramatically. Unless and until we see structural change at home and abroad, our portfolios will remain conservative. But we should not confuse conservatism with cash. Every piece of data we can find shows that a conservative portfolio can meet our clients goals over time, and cash cannot.
Finally, Wagner Wealth Management is pleased to announce it has been included in the National Association of Board Certified Advisory Practices’ (NABCAP) Premier Advisor list for 2011, published by the Denver Business Journal on September 30, 2011. The list recognizes advisory practices in the Denver area that represent the best in quality wealth management. There were six firms recognized as “stars” in certain fields, and we are proud to have been selected as a “risk management star.” Advisors selected for the list participated in NABCAP’s unaffiliated evaluation process which assessed 20 categories of practice management. Categories examined included: planning, investment, and risk philosophy; fee structure; years of experience; credentials and designations; team dynamics; and customer service, among others.
Please feel free to call us with any questions or if you’d like to discuss our thoughts in more detail.
The Wagner Wealth Team
* Information provided should not be construed as investment advice and is not meant to be taken as a recommendation to buy or sell. The financial situation and investment objectives of each individual must be considered for suitability prior to any recommendations being made.