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How much do shareholders in 401(k) and other retirement vehicles influence market fluctuation? I think about my book of clients are not making big changes...moving in and out of the market. From where does big market fluctuation come? Institutional investors? speculators?

It is hard to find exact data but the chart below suggests that retirement plans are the biggest owners of the stock market – almost 40%. In January there were big flows into equity mutual funds and etf’s as retail investors were finally coming to the table. Speculators were also joining the party because it seemed like the market would never go down. I don’t have the flow data from last week yet but I suspect it was a combination if skittish retail investors, speculators and the use of quantitative algorithms which can speed up sell offs. For every sell there has to be a buy. Therefore, the selloff was actually lot of buying too. Fundamental are extremely strong - corporate earnings continue to accelerate. So we remain bullish on the market. Corrections and pullbacks are normal!

Thoughts on real estate?

The housing market is doing well but supply constraints continue to push prices higher. The recent increase in mortgage rates will not have a huge impact on sales and the U.S. housing market remains attractive. However, I think you may be asking about REITS. REITS have recently underperformed the broader market because of the move higher in interest rates but have also lagged significantly over the last two years. Here are some thoughts from our REIT team.

  • REITs are selling off due to the sharp move up in treasury rates as they have done in prior periods
    • Global REITs have declined -7% year-to-date versus the S&P 500 -1.8% thru Friday Feb 9th
    • U.S. REITs have declined -11% thru Friday
  • Earnings season to date has reinforced that property fundamentals are as we expected – stable to improving
  • Corporate spreads have tightened, rates are increasing for the “right reasons” with expected better economic growth
  • Property stocks are now materially discounted:
    • U.S. REITs trade at a 13% discount to Net Asset Value (NAV) and global REITs trade at a 15% discount to NAV, which is our estimate of the value of the underlying real estate
    • REITs are trading at historically cheap valuations (both absolute & relative to other equity and fixed-income alternatives)
    • Attractively valued relative to broad equities
  • Rate-driven selloffs have historically created opportunities for solid future absolute and relative returns.
  • Looking at the last interest rate increase period, Global REITS performed very well.

    (see page 32 of the Global Perspectives Book™).

    Rising interest rates - lower bond prices. What are your suggestions for fixed income in a 60/40 portfolio?

    Sure, if you have long treasury bonds, January has not been kind. But high yield and global bonds are actually up so far this year. A 60/40 portfolio would do well to be diversified across both stocks and bonds. Bonds provide a steady stream of income and risk control so that investors can own stocks and sleep at night. Long treasury bonds are negatively correlated to stocks and usually go up when stocks go down. In 2008 the S&P was down 37% but long treasury bonds were up 33%. And senior loans do well in rising rate environments because they have floating rates. In fact, many variations of bonds can do well in Fed tightening periods (see page 32 of the Global Perspectives Book™). Bonds may feel like a drag now but if we finally see a correction, investors will be glad they have them. So I advocate for bonds in a portfolio all of the time. Just make sure you are diversified. In addition, we anticipate that rate increases will temper as there is still high demand for U.S. bonds from Europe and Japan where rates are lower.

    We are kind of stumped about what the PMI is measuring. Specifically, what does the percentage measure? Is there such a thing as 100% of "something"?

    PMI is a diffusion index which is a fancy way of measuring the breadth of expansion or contraction in manufacturing. It never hits 100%. The highest it ever got in 1950s was 70%. There are 5 components and I will show you how the most important works. New Orders Dec 2017 - 37% was better ; 55% was the same ; 8% was worse compared to last month. Basically they take 1/2 55% (same) + 37% positive add together and then seasonally adjust for all five. Bottomline: Ignore everything else...if its over 50 it is good, if it is near 60 it is not only good but the breadth is broadening to every sector.

    What is your opinion on high bonds now and into 2018?

    The U.S. Corporate High Yield has a yield (YTW) of 5.68% and YTD total return of 7.18%. Therefore YTD return was driven by narrowing spreads and marginally lower rates. The spread refers to the premium over treasuries and reflects improved profitability. The lower rates reflect lower expectation of growth. I expect high yield bonds to return close to its current yield. I expect on our expectation of solid corporate earnings spreads may narrow further providing a marginally capital gain. I do expect rates to go up to 2.70% and that will somewhat hurt high yield. The bottomline though is high yield beats all of the rest on income with – what I am forecasting – not too much downside risk. Hope that helps.

    October 30, 2017 - Have you been looking at 2018? If so, what is your opinion domestic and international markets?

    Earnings are expected to increase double digits in 2018 so we are very bullish. Most companies are not pricing in tax cuts so this will be an additional positive. Investors are missing the fact that we are in the midst of a global synchronized expansion. Of the 45 OECD economies, 45 out of 45 are expanding. This is creating a virtuous cycle and global earnings are expanding. Therefore, we see good things for domestic and international markets in 2018. But as always, we advocate global diversification across stocks and bonds so when volatility inevitably rears its head, investors will be able to sleep at night. Hope that helps!

    October 6, 2017 - Clients have begun to "hear" the media as they report on the impending "market correction." Is this a realistic fear? How is this different from the upside risk that you mentioned in your 9/27 write-up?

    Investors have become accustom to ultra-low market volatility. Corrections are normal but we have not seen one in so long, its sure to rattle investors when we finally do. However, I don’t see a severe correction on the horizon. The economic data is just so darn good, not just here in the U.S. but also globally. It is not often that almost all global economies are moving forward in a synchronized expansion. And earnings, the fundamental driver of markets, continue to move higher. Therefore, any time we see a little bit of a selloff, there are plenty of investors willing to swoop in and buy on the dips. If Washington passes tax reform, markets will go even higher. So the path of least resistance is up not down. That is what we mean by upside risk – the market going higher and investors missing out by sitting on the sidelines in fear. We advocate global diversification to help smooth the bumps (corrections) when they do occur. But the biggest risk in the last few years has not been Washington, North Korea, etc. It has been not being in the market. It is realistic to expect a correction at some point but not to fear it. A correction would actually be a buying opportunity.

    September 29, 2017 - What are your thoughts about using preferred stocks as a bond surrogate, particularly as we look at another Fed raise this year and three next year? And how would you compare the idea against using senior loans?

    I like the diversification and dividend tax treatment of preferred stocks. Preferred stocks are very bond like but often have higher yields because the dividends are not guaranteed and preferreds usually have call provisions. Yes, the Fed will continue to increase short term rates and I see long term interest rates ticking up but not a dramatic rise, so I think preferreds will do well. Credit conditions are generally quite good so risk of default remains low. And calls occur when rates go down not up. Keep in mind not every company issues preferred stock therefore, you may have limited options and the reason they have a higher yield is because they are more risky. Senior loans will obviously shine if we see a dramatic spike in interest rates because they have zero duration. But even if interest rates remain subdued, I still like Senior Loans as an all-weather asset class. Low defaults, higher recovery rates than high yield bonds and long term returns of around 5% make them attractive in any market. So I would advocate for both, not one or the other.

    September 21, 2017 - I was wondering whether you can shed some light on whether, in your opinion, the senior loans segment remains one that can generate decent relative returns. A lot of noise lately on weaker covenants and too much money chasing that asset class with few banks suggesting to exit the strategy. A couple of lines highlighting your stance would be much appreciated.

    Yes, I still think they Senior Loans are an attractive asset class. In anticipation of a rate surge last year, many investors jumped on Sr Loans driving prices up. But Senior Loans are a good all weather asset. If interest rates rise, they will do well. But even if rates don’t rise they provide coupon interest of 4.6% average, lower defaults and higher recovery rates than high yield bonds if credit conditions were to materially weaken. Our Voya Senior Loan team goes through a rigorous credit underwriting process for each new deal and I have not heard anything about weaker covenants. If you look at the long term averages, Senior Loans are the steady Eddie, returning about 5% with no duration risk.

    September 21, 2017 - The Feds are going to start selling the bonds that they bought for the quantitative easing. They say they are keeping the rates the same until maybe Dec. If they are selling bonds are they really keeping rates the same? The whole unwinding of the quantitative easing seems to be a continuation of the same experiment that no one knows the end result. I Have even heard some refer to it as another 1937. The market is on a roll right now and does not seem to care what the news is and just goes up. Almost seems like bubble time again. What do you think?

    No one is really sure what will happen for sure but the market is general sanguine about the runoff for a few reasons. The Fed is going to be taking baby steps and the runoff each month is likely to be very small. Second, other global central banks are still accommodative and buying bonds. Third, the global economy is getting stronger and rates should be going higher. And finally, many think the Fed was overstepping its bounds by buying bonds in the first place. Manipulating rates leads to misallocation of capital and mispricing of assets. Perhaps the Fed’s interference actually suppressed economic growth by propping up weaker players. Normalization may get bumpy but it is better for the long term economic growth outlook. We are not quite sure of the benefit the program had on the upside and are therefore not sure of the implications on the exit. However, corporate earnings are the true driver of markets and if they can continue to move forward the market will follow. The lineup is not always a straight line but I’m not worried right now. Global diversification across stocks and bonds is the best way to participate in the market with somewhat of a cushion against any potential market downturns.


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