Monthly Markets Memo - November 2015
Our thoughts and prayers go to the families affected by the terrorist attacks and for the people of France. It is always difficult to understand how some have such a lack of regard for human life. However, it is at times like these that we are grateful for the many good people who will stay enlisted in the effort to make our world safer.
Global Economy Perspective
The month of October was good for most equity markets as they re-gained many of the returns they lost over the prior quarter. However, concerns in the global economy and the anticipated rise in U.S. interest rates has caused volatility to return in the first half of November.
Valuations in the U.S. equity markets, outside of some sectors and individual equities, are not cheap after a difficult earnings quarter. A significant amount of the disappointing earnings can be blamed on the fact that energy companies are dealing with the lower price of oil and many multi-national companies face the head wind of a more expensive currency than their international competitors. While we still think the U.S. economy can continue to grow along with U.S. Corporate profits, many of the companies in the U.S. are trading at valuations that are much higher than they were just a couple of years ago.
While at first glance the valuations in European equities don’t look much better than ours, their potential for upward surprises to profits and cash flow appear to be more likely than here in the U.S. The U.S. has already surpassed its economic and market performance prior to the financial crisis of 2008-2009. Whereas Europe had a second recession after the financial crisis so companies may now be operating in a positive economic environment with stabilizing growth for the first time in a long while. With some help by the European Central Bank (ECB), with its current aggressive monetary policy, this gives European companies the opportunity to fulfil their earnings potential as the economy grows.
It has recently been reported that Japan has now experienced another mild recession, however it is important to note that the economic numbers for the fourth quarter appear improved. In addition, a potential positive aspect of investing in Japan is that their economy does not have to do particularly well in order for equity investors to receive positive returns. Many of their companies have more sensitivity to economies other than their own. This is due to the fact that a significant amount of their revenues come from exports rather than a reliance on domestic spending. Having said this, the domestic consumer spending over the last quarter actually showed some strength. If the export companies who have benefited from a significantly cheaper currency begin increasing investment in both capital and people, the local economy could advance as well. Many of those companies already have a significant amount of cash on the balance sheet. There has been growing political and investor pressure on these companies to put these resources to work. If they were to invest these resources well, investors would be able to participate in their increased profits over time.
As the end of the calendar year approaches, many investors with taxable investment accounts may be wondering how much in gains they will have to report next year. Many taxable accounts contain investments in mutual funds which may distribute capital gains whether the fund has appreciated through the year or not. These gains are due to the fact that the fund passes through the net tax effect of the individual sales (equity and bond) made during the year. In other words, the fund’s total portfolio performance is separate from the tax consequences that it produces throughout the year. In fact, after five years of positive returns in the markets many of the ‘buy and hold’ managers may incur more tax consequences than in prior years. This is simply due to the fact that they purchased a stock, perhaps years ago, but held on until they fell it was time to realize the gain that the security made. So, a fund comprised of a portfolio of stocks that have moved up over the years, may be re-positioning these holdings which results in the sale of securities with significant gains.
At Vantage, we consider opportunities to reduce taxable gains as part of our investment philosophy. These opportunities must be weighed in light of the primary goal of the strategy and goals of the client. One method we can employ is that when a fund has a sizeable gain to be distributed but our position has a lower gain or even a loss is to sell the position and replace it with a similar security. This effort is known as tax harvesting and is one example of how we combine financial planning into our investment philosophy where and when possible.
As we look forward, we see a somewhat sporadic economy and equity markets that will continue to be volatile. This does not change our view however, that owning stocks rather than bonds is still the best long term strategy. The low interest rates, slow but positive signs that the consumer will continue to spend and still good job growth allows us to stay comfortable with our overweight allocation to equities.
Darkness cannot drive out darkness: only light can do that. Hate cannot drive out hate: only love can do that.
Dr. Martin Luther King, Jr.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies are revealed, this post is not intended nor does it reflect transactions within any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from accurate sources but is not warranted to be correct, complete or accurate. Statistical data has been obtained from sources including but not limited to www.bea.gov, www.bls.gov and www.morningstar.com.