15 Costly retirement mistakes

15 Costly retirement mistakes

15 Costly retirement mistakes… Retirement is a major milestone for many Americans. Retiring marks the end of your working life and the beginning of a new chapter. As a financial advisor, my job is to help my clients avoid mistakes and retire with confidence and peace of mind.  Together we build a solid roadmap to retirement and a gameplan to achieve your financial goals. My role as a financial advisor is to provide an objective and comprehensive view of my clients’ finances.  As part of my process, I look for any blind spots that can put my clients’ plans at risk.  Here is a list of the major retirement mistakes and how to avoid them.

1. Not planning ahead for retirement

Not planning ahead for retirement can cost you a lot in the long run. Delaying to make key decisions is a huge retirement mistake that can jeopardize your financial security during retirement. Comprehensive financial planners are more likely to save for retirement and feel more confident about achieving their financial goals.  Studies have shown that only 32% of non-planners are likely to have enough saved for retirement versus 91% of comprehensive planners.

Reviewing your retirement plan periodically will help you address any warning signs in your retirement plan. Recent life changes, economic and market downturns or change in the tax law could all have a material impact on your retirement plans. Be proactive and will never get caught off guard.

2. Not asking the right questions

Another big retirement mistake is the fear of asking the right question. Avoiding these

Here are some of the questions that my clients are asking –

  • “Do I have enough savings to retire?”
  •  “Am I on the right track?”.
  • “Can I achieve my financial goals?”
  • “Can I retire if the stock market crashes?”.
  • “Are you fiduciary advisor working in my best interest?” (Yes, I am fiduciary)

Asking those tough questions will prepare you for a successful retirement journey. Addressing your concerns proactively will take you on the right track of meeting your priorities and achieving your personal goals

3. Not paying off debt

Paying off debt can be an enormous burden during retirement. High-interest rate loans can put a heavy toll on your finances and financial freedom. As your wages get replaced by pension and social security benefits, your expenses will remain the same. If you are still paying off loans, come up with a plan on how to lower your debt and interest cost. Being debt-free will reduce the stress out of losing viable income.

4. Not setting goals

Having goals is a way to visualize your ideal future. Not having goals is a retirement mistake that can jeopardize your financial independence during retirement. Without specific goals, your retirement planning could be much harder and painful. With specific goals, you have clarity of what you want and what you want to achieve. You can make financial decisions and choose investment products and services that align with your objectives and priorities. Setting goals will put you on a successful track to enjoy what matters most to you.

5. Not saving enough

An alarming 22% of Americans have less than $5,000 in retirement savings. The average 401k balance according to Fidelity is $103,700. These figures are scary. It means that most Americans are not financially ready for retirement. With ultra-low interest rates combined with constantly rising costs of health care,  future retirees will find it difficult to replace their working-age income once they retire. Fortunately, many employers now offer some type of workplace retirement savings plans such as 401k, 403b, 457, TSP or SEP IRA. If your employer doesn’t offer any of those, you can still save in Traditional IRA, Roth IRA, investment account or the old fashioned savings account.

6. Relying on one source for retirement income

Many future retirees are entirely dependent on a single source for their retirement income such as social security or pension.  Unfortunately. with social security running out of money and many pension plans shutting down or running a huge deficit, the burden will be on ourselves to provide reliable income during our retirement years. If you want to be financially independent, make sure that your retirement income comes from multiple sources.

7. Lack of diversification

Diversification is the only free lunch you can get in investing and will help decrease the overall risk of your portfolio. Adding uncorrelated asset classes such as small-cap, international and emerging market stocks, bonds, and commodities will reduce the volatility of your investments without sacrificing much of the expected return in the long run.

A common mistake among retirees is the lack of diversification. Many of their investment portfolios are heavily invested in stocks, a target retirement fund or a single index fund.

Furthermore, owning too much of one stock or a fund can cause significant issues to your retirement savings. Just ask the folks who worked for Enron or Lehman Brothers who had their employer’s stocks in their retirement plans. Their lifetime savings were wiped out overnight when these companies filed for bankruptcy.

8. Not rebalancing your investment portfolio

Regular rebalancing ensures that your portfolio stays within your desired risk level. While tempting to keep a stock or an asset class that has been on the rise, not rebalancing to your original target allocation can significantly increase the risk of your investments.

9. Paying high fees

Paying high fees for mutual funds and high commission insurance products can eat up a lot of your return. It is crucial to invest in low-cost investment managers that can produce superior returns over time. If you own a fund that has consistently underperformed its benchmark,  maybe it’s time to revisit your options.

Many insurance products like annuities and life insurance while good on paper, come with high upfront commissions, high annual fees, and surrender charges and restrictions.  Before signing a contract or buying a product, make sure you are comfortable with what you are going to pay.

10. No budgeting

Adhering to a budget before and during retirement is critical for your confidence and financial success. When balancing your budget, you can live within your means and make well-informed and timed decisions. Having a budget will ensure that you can reach your financial goals.

11. No tax planning

Not planning your taxes can be a costly retirement mistake. Your pension and social security are taxable. So are your distributions from 401k and IRAs. Long-term investing will produce gains, and many of these gains will be taxable. As you grow our retirement saving the complexity of assets will increase. And therefore the tax impact of using your investment portfolio for retirement income can be substantial. Building a long-term strategy with a focus on taxes can optimize your after-tax returns when you manage your investments.

12. No estate planning

Many people want to leave some legacy behind them. Building a robust estate plan will make that happen. Whether you want to leave something to your children or grandchildren or make a large contribution to your favorite foundation, estate, and financial planning is important to secure your best interests and maximize the benefits for yourself and your beneficiaries.

13. Not having an exit planning

Sound exit planning is crucial for business owners. Often times entrepreneurs rely on selling their business to fund their retirement. Unlike liquid investments in stocks and bonds, corporations and real estate are a lot harder to divest.  Seling your business may have serious tax and legal consequences. Having a solid exit plan will ensure the smooth transition of ownership, business continuity, and optimized tax impact.

14. Not seeing the big picture

Between our family life, friends, personal interests, causes, job, real estate properties, retirement portfolio, insurance and so on, our lives become a web of interconnected relationships. Above all is you as the primary driver of your fortune. Any change of this structure can positively or adversely impact the other pieces. Putting all elements together and building a comprehensive picture of your financial life will help you manage these relationships in the best possible way.

15. Not getting help

Some people are very self-driven and do very well by planning for their own retirement. Others who are occupied with their career or family may not have the time or ability to deal with the complexities of financial planning. Seeking help from a fiduciary financial planner can help you avoid retirement mistakes. A fiduciary advisor will watch for your blind spots and help you find clarity when making crucial financial decisions.

Market Outlook October 2019

market Outlook October 2019

Highlights:

  • S&P 500 recorded a modest gain of 0.9% in the third quarter of 2019
  • Ten-year treasury rate dropped to 1.5% before bouncing back to 1.75%
  • S&P 500 dividend yield is now higher than the 20-year treasury rate
  • Manufacturing index hits contraction territory

Economic Overview

  • The US economy continues to show resiliency despite increased political uncertainty and lower business confidence
  • The consumer sentiment – The US consumer is going strong. Consumer sentiment reached 93 in September 2019. While below record levels, sentiment remains above historical levels. Consumer spending, which makes up 68% of the US GDP, continues to be the primary driver of the economy.
Market Outlook October 2019 Consumer Sentiment
Consumer Sentiment
  • Unemployment hits 3.5%, the lowest level since 1969
  • Wage growth of 2.9% remains above-target inflation levels
  • Household debt to GDP continues to trend down and is now at 76%.
Market Outlook October 2019
Household debt to GDP
  • Fed rate cuts – Fed announced two rate cuts and is expected to cut twice until the end of the year.
  • The 10-year treasury rate is near 1.75%
  • The 30-year mortgage rate is near 3.75%
  • While low-interest rates and low unemployment continue to lift consumer confidence, the question now is, “Can the US consumer save the economy from recession’?
  • The probability of recession is getting higher. Some economists assign a 25% chance of recession by the end of 2020 or 2021.
  • The ISM Manufacturing index dropped to 47 in September, falling under for a second consecutive month. Typically readings under 50 show a sign of contraction and reading over 50 points to expansion. The ISM index is a gauge for business confidence and shows the willingness of corporate managers to higher more employees, buy new equipment and reinvest in their business.
  • Trade war – What started as tariff threats in 2018 have turned into a full-blown trade war with China and the European Union. The Trump administration announced a series of new import tariffs for goods coming from China and the EU. China responded with yuan devaluation and more tariffs. France introduced a new digital tax that is expected to impact primary US tech giants operating in the EU.
  • A study by IHS Markit’s Macroeconomic Advisers calculated that gross domestic product could be boosted by roughly 0.5% if uncertainty over trade policy ultimately dissipates.
  • Chinese FX and Gold reserves – China’s reserve assets dropped by $17.0b in September, comprising of $14.7bn drop in FX reserves and a $2.4bn decline in the gold reserves. China has been adding to its gold reserves for ten straight months since December 2018.
  • Political uncertainty – Impeachment inquiry and upcoming elections have dominated the news lately. Fears of political gridlock and uncertainty are elevating the risk for US businesses.
  • Slowing global growth – The last few recessions were all domestically driven due to asset bubbles and high-interest rates. This time could be different, and I do not say that very often. Just two years ago, we saw a consolidated global growth with countries around the world reporting high GDP numbers. This year we witness a sharp turn and a consolidated global slowdown. EU economies are on the verge of recession. The only thing that supports the Eurozone is the negative interest rates instituted by the ECB. China reported the slowest GDP growth in decades and announced a package of fiscal spending combined with tax cuts, regulatory rollbacks, and targeted monetary easing geared to offset the effect of the trade war and lower consumer spending. So even though the US economy is stable, a prolonged slowdown of global economies could drag the US down as well.

Equities

US Equities had a volatile summer. Most indices are trading close to or below early July levels and only helped by dividends to reach a positive quarterly return. On July 27, 2019, S&P 500 closed at an all-time high of 3,025, followed by an August selloff. A mid-September rally helped S&P 500 pass 3,000 level again, followed by another selloff. S&P 500 keeps hovering near all-time highs despite increased volatility, with 3,000 remaining a distinct level of resistance.

In a small boost for equities, the dividend yield on the S&P 500 is now higher than the 10- and 20- year US Treasury rate and barely below the 30-year rate of 2%.

For many income investors equities become an alternative to generate extra income over safer instruments such as bonds

Market Outlook October 2019
S&P 500 dividend versus 20-year treasury rate

Growth versus Value

Investing in stocks with lower valuations such as price to earnings and price to book ratios has been a losing strategy in the past decade. Investors have favored tech companies with strong revenue growth often at the expense of achieving profits. They gave many of those companies a pass in exchange for a promise to become profitable in the future.

However, while economic uncertainty is going up, the investors’ appetite for risk is going down. The value trade made a big comeback over the summer as investors flee to safe stocks with higher dividends. As a result, the utilities and consumer staple companies have outperformed the tech sector.

The IPO market

The IPO market is an indicator of the strength of the economy and the risk appetite of investors. In 2019, we had multiple flagship companies going public. Unfortunately, many of them became victims of this transition to safety. Amongst the companies with lower post IPO prices are Uber, Lyft, Smiles Direct Club, and Chewy.com. Their shares were down between -25% and -36% since their inception date. Investors walked away from many of these names looking for a clear path to profitability while moving to safety stocks.

Market Outlook October 2019, Uber and Lyft since IPO

Small-Cap

Small caps have trailed large caps due to increased fears of recession and higher market volatility. Small caps tend to outperform in a risk-on environment, where investors have a positive outlook on the economy.

Market Outlook October 2019, Small Cap versus Large Cap

International Stocks

International stocks continue to underperform. On a relative basis, these stocks are better valued and provide a higher dividend than US stocks. Unfortunately, with a few exceptions, most foreign stocks have been hurt by sluggish domestic and international demand and a slowdown in manufacturing due to higher tariffs. Many international economies are much more dependent on exports than the US economy.

Fixed Income

The Fed continued its accommodative policy and lowered its fund rate twice over the summer. Simultaneously, other Central Banks around the world have been cutting their rates very aggressively.

The European Central Bank went as far as lowering its short-term funding rate to -0.50%. As a result, the 30-year German bund is now yielding -0.03%. The value of debt with negative yield reached $13 trillion worldwide including distressed issuers such as Greece, Italy, and Spain.

Investors who buy negative-yielding bonds are effectively lending the government free money.

In one of my posts earlier in 2019, I laid out the dangers of low and negative interest rates. You can read the full article here. In summary, ultra-low and negative interest rates change dramatically the landscape for investors looking to supplement their income by buying government bonds. Those investors need to take more risk in their search for income. Low rates could also encourage frivolous spending by politicians and often lead to asset bubbles.

The Yield Curve

The yield curve shows what interest rate an investor will earn at various maturities. Traditionally, longer maturities require a higher interest rate as there is more risk to the creditor for getting the principal back. The case when long-term rates are lower than short-term rates is called yield inversion. Some economists believe that a yield inversion precedes a recession. However, there is an active debate about whether the difference between 10y and 2y or 10y and 3m is a more accurate indicator.

Market Outlook October 2019, Yield Curve

As you can see from the chart, the yield curve gradually inverted throughout the year. Short-term bonds with 3-month to maturity are now paying higher interest than the 10-year treasury

Credit spreads

The spread between AAA investment-grade and lower-rated high yield bonds is another indicator of an imminent credit crunch and possible economic slowdown.

Market Outlook October 2019, Credit Spreads

Fortunately, corporate rates have been declining alongside treasury rates. Spreads between AAA and BBB-rated investment grade and B-rated high yield bonds have remained steady.

Repo market crisis

The repo market is where banks and money-market funds typically lend each other cash for periods as short as one night in exchange for safe collateral such as Treasuries. The repo rates surged as high as 10% in mid-September from about 2.25% amid an unexpected shortage of available cash in the financial system. For the first time in more than a decade, the Federal Reserve injected cash into the money market to pull down interest rates.

The Fed claimed that the cash shortage was due to technical factors. However, many economists link the shortages of funds as a result of the central bank’s decision to shrink the size of its securities holdings in recent years. The Fed reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system.

Gold

Gold has been a bright spot in our portfolio in 2019. After several years of dormant performance, investors are switching to Gold as protection from market volatility and low-interest rates. In early September, the precious metal was up nearly 21% YTD, but since then, retracted a bit.

Market Outlook October 2019, Gold

Gold traditionally has a very low correlation to both Equities and Bonds. Even though it doesn’t generate income, it serves as an effective addition to a well-diversified portfolio.

The Gold will move higher if we continue to experience high market volatility and uncertainty on the trade war.

Final words

The US economy remains resilient with low unemployment, steadily growing wages, and strong consumer confidence. However, few cracks are starting to appear on the surface. Many manufacturers are taking a more cautious position as the effects of the global slowdown and tariffs are starting to trickle back to the US. An inverted yield curve and crunch in the repo market have raised additional concerns about the strength of the economy.

Despite the media’s prolonged crisis call, we can avoid a recession. The recent trade agreement between the US and Japan could open the gate for other bilateral trade agreements. Given that the US elections are around the corner, I believe that this administration has a high incentive to seal trade agreements with China and the EU.

The market is expecting two more Fed cuts for a total of 0.5% by the end of the year. If this happens, the Fed fund rate will drop to 1.25% – 1.5%, possibly flattening or even steepening the yield curve, which will be a positive sign for the markets.

Those with mortgage loans paying over 4% in interest may wish to consider refinancing at a lower rate.

Market volatility is inevitable. Keep a long-term view and maintain a well-diversified portfolio.

The end of the year is an excellent time to review your retirement and investment portfolio, rebalance and take advantage of any tax-loss harvesting opportunities.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is the founder of Babylon Wealth Management and a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning and investment management for growing families, physicians, and successful business owners.

If you have any questions about the markets and your investments, reach out to me at stoyan@babylonwealth.com or +1-925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

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Market Outlook July 2019

Market Outlook July 2019

Breaking records

So far 2019 has been the year of breaking records. We are officially in the longest economic expansion, which started in June of 2009. After the steep market selloff in December, the major US indices have recovered their losses and reached new highs. The hopes for a resolution on trade, the Fed lowering interest rates and strong US consumer spending, have lifted the markets.  At the same time, many investors remain nervous fearing an upcoming recession and slowing global growth.

S&P 500 in record territory

S&P 500 hit an all-time high in June, which turned out to be best June since 1938. Furthermore, the US Large Cap Index had its best first quarter (January thru March) and the best first half of the year since the 1980s.

S&P 500 Performance since January 2018
Market Outlook July 2019

US treasuries rates declined

Despite the enthusiasm in the equity world, fixed income investors are ringing the alarm bell. 10-year treasury rate dropped under 2%, while 2-year treasuries fell as low as 1.7%.

10-year Treasury versus 2-year treasury and 3-month treasury.

We continue to observe a persistent yield inversion with the 3-month treasury rates higher than 2-year and 10-year rates. Simultaneously, the spread between the 2 and 10-year remains positive. Historically, a yield inversion has been a sign for an upcoming recession. However, most economists believe that the 2-10-year spread is a better indicator than the 3m-10-year spread.

Gold is on the move

Gold passed 1,400. With increased market volatility and investors fears for a recession, Gold has made a small comeback and reached $1,400, the highest level since 2014.

Bonds beating S&P 500

Despite the record highs, S&P 500 has underperformed the Bond market and Gold from October 2018 to June 2019 S&P 500 is up only 1.8% since October 1, 2018, while the 10-year bond rose 8.7% and Gold gained 16.8%. For those loyal believers of diversification like myself, these figures show that diversification still works.

S&P 500 versus 10-year treasury and Gold

Defensive Stocks lead the rally in Q2

Consumer Staples and Utilities outperformed the broader market in Q2 of 2019. The combination of lower interest rates, higher market volatility and fears for recessions, have led many investors into a defensive mode. Consumer staples like Procter & Gamble and Clorox together with utility giants like Southern and Con Edison have led the rally in the past three months.

Utilities and Consumer Staples performance versus S&P 500.

Small-Cap lagging

Small cap stocks are still under all-time high levels in August of 2018. While both S&P 600 and Russell 2000 recovered from the market selloff in December o 2018, they are still below their record high levels by -13.6% and 10% respectively

S&P 600 and Russell 2000 9-month performance.

International Stocks disappoint

International Developed and Emerging Stocks have also not recovered from their record highs in January of 2018.  The FTSE International Developed market index is 13.4% below its highest levels. While MSCI EM index dropped nearly 18.3% from these levels.

International stocks performance

The Fed

After hiking their target rates four times in 2018, the Fed has taken a more dovish position and opened the door for a possible rate cut in 2020 if not sooner. Currently, the market is expecting a 50-bps to a 75-bps rate cut by the end of the year.

As I wrote this article, The Fed chairman Jerome Powell testified in front of congress that crosscurrents from weaker global economy and trade tensions are dampening the U.S. economic outlook. He also said inflation continues to run below the Fed’s 2% target, adding: “There is a risk that weak inflation will be even more persistent than we currently anticipate.”

Unemployment

The unemployment rate remains at a record low level at 3.7%. In June, the US economy added 224,000 new jobs and 335,000 people entered the workforce. The wage growth was 3.1%.

Consumer spending

The US consumer confidence remains high at 98 albeit below the record levels in 2018. Consumer spending has reached $13 trillion. Combined with low unemployment, the consumer spending will be a strong force in supporting the current economic expansion.

Manufacturing is weakening

The Institute for Supply Management (ISM) reported that its manufacturing index dropped to 51.7 in June from 52.1 in May. Readings above 50 indicate activity indicate expanding, while those below 50 show contraction. While we still in the expansion territory, June 2019 had the lowest value since 2016. Trade tensions with China, Mexico, and Europe, and slowing global growth have triggered the alarm as many businesses are preparing for a slowdown by delaying capital investment and large inventory purchases.  

Trade war truce for now

The trade war is on pause. After a break in May, the US and China will continue their trade negotiations. European auto tariffs are on hold. And raising tariffs on Mexican goods is no longer on the table (for now). Cheering investors have lifted the markets in June hoping for a long-term resolution.

Dividend is the king

With interest rates remaining low, I expect dividend stocks to attract more investors’ interest. Except for consumer staples and utilities, dividend stocks have trailed the S&P 500 so far this year. Many of the dividend payers like AT&T, AbbVie, Chevron, and IBM had a lagging performance. However, the investor’s appetite for income could reverse this trend.

The 3,000

As I was writing this article the S&P 500 crossed the magical 3,000. If the index is able to maintain this level, we could have a possible catalyst for another leg up of this bull market.

The elections are coming

The US Presidential elections are coming.  Health Care cost, rising student debt, income inequality, looming retirement crisis, illegal immigration, and the skyrocketing budget deficit will be among the main topics of discussion. Historically there were only four times during an election year when the stock market crashed. All of them coincided with major economic crises – The Great Depression, World War II, the bubble, and the Financial crisis.  Only one time, 1940 was a reelection year.

S&P 500 Returns During Election Years

YearReturnCandidates
192843.60%Hoover vs. Smith
1932-8.20%Roosevelt vs. Hoover
193633.90%Roosevelt vs. Landon
1940-9.80%Roosevelt vs. Willkie
194419.70%Roosevelt vs. Dewey
19485.50%Truman vs. Dewey
195218.40%Eisenhower vs. Stevenson
19566.60%Eisenhower vs. Stevenson
19600.50%Kennedy vs. Nixon
196416.50%Johnson vs. Goldwater
196811.10%Nixon vs. Humphrey
197219.00%Nixon vs. McGovern
197623.80%Carter vs. Ford
198032.40%Reagan vs. Carter
19846.30%Reagan vs. Mondale
198816.80%Bush vs. Dukakis
19927.60%Clinton vs. Bush
199623.00%Clinton vs. Dole
2000-9.10%Bush vs. Gore
200410.90%Bush vs. Kerry
2008-37.00%Obama vs. McCain
201216.00%Obama vs. Romney
201611.90%Trump vs. Clinton

Final words

The US Economy remains strong despite headwinds from trade tensions and slowing global growth. GDP growth above 3% combined with a possible rate cut lat and resolution of the trade negotiations with China, could lift the equity markets another 5% to 10%.

Another market pullback is possible but I would see it as a buying opportunity if the economy remains strong.

If your portfolio has extra cash, this could be a good opportunity to buy short-term CDs at above 2% rate.

Reach out

If you have any questions about the markets and your investment portfolio, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

Market Outlook April 2019

Market Outlook April 2019

In my last commentary in early January, right after the December vortex, I gave 30% chance that the bull market will recover and 50% chance that we will see more volatility in the upcoming six months.  My view of the economy was still positive. And I didn’t see reasons for a recession at that time. I was somewhat right and wrong. My market outlook remains cautiously positive. Let’s break it down.

Equity markets

The markets were a little bit choppy at the beginning of January and the end of March. But overall all major equity markets in the US and abroad posted impressive quarterly performance. In fact, it was the S&P 500’s best quarter in decades. The S&P 500 index rose by 13% in the first three months of the year. Russell 2000 added 14.3%. The international stocks grew by about 10%.

Major markets' performance between January 2018 and Match 2019.

However, to put that in perspective, the S&P 500 is still a few percentage points below its all-time high in September of 2018. At the same time, Small caps are nearly 13% below its highest mark. While International Developed and Emerging Market stocks have been in a steep decline since their highs in January of 2018 and haven’t even come close to these levels.

So, I was wrong because, despite a few volatile trading days, the market remained relatively calm. The Q1 standard deviation was well below the 10-year average. After the Fed chair Jerome Powell stated that the Fed would be more cautious in raising interest rates in 2019 after their initial forecast of three rate hikes, the market took a leap of faith.

The US and international markets continue to diverge. The chart above shows the difference in performance between these two markets.

Growth versus value

Another interesting story is the growing gap between Growth and Value stocks. Value stocks have done pretty much nothing in the past 15 months while growth stocks have been a power horse.

Equity markets show a gap between Growth versus value stocks .

The trade wars

We also got mixed but mostly positive news from the US-China trade negotiations. The investors want the deal, and both sides seem motivated to strike one. The truth is that the US is the biggest market for Chinese export and China is the biggest market for US tech and industrial giants.  However, a lot of the issues with intellectual property and copyright protection, government subsidies and influence on corporate boards, privacy concerns, limited market access to China for US companies and so on, have accumulated for decades. But It will take more than a handshake to get these issues resolved.

Fixed Income Markets

The fixed-income traders have probably seen better days. For the first time in over a decade, the 10-year treasury rate is lower than the 3-month treasury rates. The maturity premium is now negative. This type of rate tightness is known as an inverted yield curve. The yield inversion has historically preceded all economic recessions. But not all inverted yield curves have led to a recession.

Fixed Income Markets are in turmoil. Comparing 3-month, 2-year and 10-year treasury rates.

This second chart below shows the gap between the Fed and Wall Street on their view of the world. The Fed who can only influence the short-end of the curve by its lending window has pushed the short-term rates by nearly 39% in the past 12 months. Those of us with saving accounts are finally seeing decent rates after ten years of drought.

Change in 3-month, 2-year and 10-year rates between January 2018 and Match 2019.

However, the long end of the curve, which is primarily determined by market supply and demand has declined by almost 12%

Soft landing or recession

The fixed income markets are waiving the red flag while the equity market remains positive. Somebody must be wrong.

Negative signals

I see a mixed bag of both positive and negative signals. On one side, US and Chinese economies continue to grow steady though with a slower pace. US Q4 GDP growth was 2.4% down from 3.4% in the third quarter of 2018. The Chinese economy expanded 6.6 percent in 2018, which is the weakest pace since 1990.

Furthermore, according to FactSet, the S&P 500 EPS estimate dropped by 7.2% (to $37.33 from $40.21) during Q1 of 2019. The decline in EPS was larger than the 5-year average (3.2%), the 10-year (3.7%), and the 15-year average (4%) cut. Additionally, payroll slowdown below forecast in the third quarter, hitting an 18-month low in March.

On the other track, Germany posted only 0.6% YoY GDP growth in 2018 with a nearly zero growth in the Q4 of 2018. Japan reported a 0.3% annual growth, after contracting -0.6% in Q3 of 2018.  Earlier in March ECB’s Mario Draghi said that there had been a “sizable moderation in economic expansion that will extend into the current year.” The ECB lowered its growth forecast for 2019 from 1.7% to 1.1%. Furthermore, the ECB halted its plans to hike rates and introduced another round of financing for European banks.

Positive signals

On the positive side, new home sales posted the highest gain in February after a steep decline in the second half of 2018. The US unemployment rate remains low at 3.8%. The US consumer sentiment went up to 98.4 in March 2019 after diving in January. The Chinese PMI surpassed economists’ estimates. New orders climbed to their highest level in four months, while the index for new export orders returned to expansionary territory.

The big question remains if the US will follow the EU and Japan into a recession/stagnation mode. Or the Fed and the Trump administration will maneuver the economy into a soft landing with slower but still healthy earnings growth, high consumer sentiment and robust business spending.

What to expect

Predicting the markets could be a treacherous task. Even successful economists sometimes make wrong conclusions. Humbly, I thought that the UK and the EU will figure out a soft Brexit, while the outcome is still hanging up in the air. I also thought that the economy would not slow down so quickly, but the combination of volatile oil prices, high interest rates, and trade war rhetoric really moved the needle in the wrong direction.  The next three to six months will be crucial to see if we are indeed heading into a slowdown or the economy is just taking a deep breath before going into another growth spurt.

The first quarter market recovery created an opportunity to take some risk off the table and rebalance your portfolio to your original risk tolerance targets.

What to watch

I am going to watch the performance of Growth versus Value stocks. In a world of slowing global economy, companies with a wide moat, high earnings growth, and big margins will continue to drive the markets. Separately, the flat yield curve and interest rates could boost interest in higher dividend paying stocks.

Also, I am going to watch the yield curve for significant moves in either direction. With short-term rates effectively higher than 10-year treasuries, for those sitting on extra cash, it might be tempting to get into one of those high-interest CDs. Currently, a 1-year CD is paying anywhere between 2.65% and 2.85%.

Contact Us

If you’d like to discuss how the market impacts your investments, please feel free to reach out and learn more about our fee-only financial advisory and OCIO services. We will meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.

Stoyan Panayotov, CFA 
Founder | Babylon Wealth Management

CFA Charterholder. Everything yu need to know about the markets. Let's build a better world for investing.
Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is the sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

Market Outlook 2019

2019 Market Outlook

Happy New Year to all!

2018 kept us on our toes. It seems that 2019 is promising to do the same.

All major world indices posted declines in 2018. S&P 500 finished lower by -4.5%. While the small-cap S&P 600 was down-8.5%. The International MSCI EAFE closed -13.8% cheaper for the year. The Bloomberg Aggregate Bond Index finished 2018 barely positive with most gains generated in the last quarter as most investors moved to Treasuries as a result of the increased volatility in the equity markets. Gold also ended in negative territory despite the 7.5% gain in the last quarter.

Major indices in 2018

Index Q1 2018 Q2 2018 Q3 2018 Q4 2018 FY 2018
S&P 500 Large-Cap (SPY) -1.00% 3.55% 7.65% -13.52% -4.56%
S&P 600 Small-Cap (IJR) 0.57% 8.69% 4.87% -20.18% -8.49%
MSCI EAFE (EFA) -0.90% -1.96% 1.52% -12.62% -13.81%
Barclays US Aggregate Bond (AGG) -1.47% -0.18% -0.08% 1.85% 0.10%
Gold (GLD) 1.73% -5.68% -4.96% 7.53% -1.94%

Source: Morningstar

We will remember 2018 with the return of volatility. Investors enjoyed relatively calm markets in 2017, which had only 8 trading days when the S&P 500 moved more than 1% in either direction, 5 down and 3 up days. For comparison, 2018 had 65 trading days when the index moved more than 1%, split evenly between positive and negative days. Overall 2018 had more positive trading days 131 versus 119. However, the average positive session was +0.69% versus the average negative session of -0.81%.

CBOE Volatility Index (^VIX) – 2017-2018

2019 Market Outlook. CBOE Volatility Index (^VIX) – 2017-2018
Source: Yahoo Finance

So, what led to this outcome. Unlike other bear markets, no single catalyst that caused this market selloff. But there was a combination of factors that formed a perfect storm and pushed the markets over the edge. In my previous post from November and December 2018, I talked about a list of these factors. Let me go over some of the most important ones.

Corporate buybacks

A big contributor to the positive returns earlier in the year was the companies’ share buybacks. After TCJA reduced the corporate tax rate to 21%, many corporations found themselves with extra cash, which they used to buyback their own stock. After the lockout period in October and the first spikes in volatility, the buybacks declined significantly.

High valuations

After a 9-year bull market and a record low-interest environment, equity valuations reached levels not seen since the tech bubble. The S&P 500 was trading at P/E of 24.9 in the early January of 2018, away above the average level of 15.7. Even after the market sell-off S&P 500 is trading around 19 P/E.

Furthermore, the Shiller PE Ratio reached 33.3, one of the highest levels in history. After the market correction, the ratio stands at 27, away above the average of 16.5.

While the traditional Price to Earnings ratio is calculated based on current or estimated earnings levels, the Schiller ratio calculates average inflation-adjusted earnings from the previous ten years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio) or PE10.

Price of Oil

After reaching $74.15 per barrel in October, US crude oil tumbled to $43, a 42% drop. While lower crude prices are pushing down on inflation, they are hurting energy stocks, which barely recovered from the previous fall in oil prices. Furthermore, the oil’s rapid decline is fueling fears for global oversupply and slowing economic growth.

The Fed’s continued hiking of interest rates in the US was not coordinated with its counterparts in the ECB, the UK, and Japan. Currently the US 10-year treasury yields 2.58%. At the same time, the German 10-year bund now yields 0.15%, while Japanese 10-year government bond went back in the negative territory of -0.01%. Combining the higher US rates with failing = Brexit talks, Italian budget crisis, and negative trade war outcome has led to a strong US dollar reaching a 17-month high versus other major currencies.

Strong dollar

Given that 40% of S&P 500 companies’ revenue comes from foreign countries, the strong dollar is making Americans goods and services more expensive and less competitive abroad. Furthermore, US companies generating earnings in foreign currency will report lower US-dollar denominated numbers.

Slowing global growth

The market decline in the last three months of 2018 came in the backdrop of strong corporate earnings and record high consumer optimism. Overall, the S&P 500 members reported record earnings in the Q3 of 2018. 78% of them have reported better than expected actual earnings with an average earnings growth rate of 25.2%.

On the other side, a growing number of companies in the S&P 500 (58 or 12%) have issued negative earnings guidance for Q4 2018 and beyond. Most recently Apple reported lower revenue guidance as a result of weak demand in China and lower than expected iPhone replacement in the US.

Corporate CFOs are starting to take a more defensive approach. Business investment grew only at a 0.8% annual rate in the third quarter, down from 8.7% in the second quarter. This was the slowest pace since the fourth quarter of 2016.

The investment bank Nomura also came out with the forecast expecting global growth to slow down. Their economists predicted that global growth in 2019 would hit 3.7% and temper to 3.5% in 2020 from 3.9% in 2018. According to Nomura, the drivers for the slowdown include waning fiscal stimulus in the U.S., tighter monetary policy from the Federal Reserve, increased supply constraints and elevated risk of a partial government shutdown.

Trade War

The impact of President Trump’s trade war is finally became obvious. With many US businesses relying on revenue from China and the EU, one company after another are starting to warn for lower revenue guidance in 2019.

The latest global PMI (Purchasing Managers Index) survey shows a slowdown in global production growth. According to JP Morgan and HIS Markit Survey: “The global manufacturing sector continued to register a subdued performance at the close of 2018. Output growth remained weak, while rates of expansion in new orders and employment both slowed. The trend in international trade flows also remained weak, with new export business declining for the fourth straight month. The JP Morgan Global Manufacturing PMI™ fell to a 27-month low of 51.5 in December, down from 52.0 in November. The average reading over the fourth quarter (51.8) was the lowest since quarter three of 2016.”

The housing market is slowing down

Both existing and new home sales have come down this year.  Rising interest rates, higher cost of materials, labor shortage and high real estate prices in major urban areas have led to a housing market slow down.  Existing home sales dropped 3.4% in September coming down for six months in a row this year. New building permits are down 5.5% over 2017.

The investors have taken a negative view of the housing market. As a result, most homebuilders, home improvement retailers, and lumber producers are trading at 52-week lows.

Consumer debt is at a record high

The US consumer debt is reaching 4 trillion dollars. Consumer debt includes non-mortgage debts such as credit cards, personal loans, auto loans, and student loans. Student loans are equal to $1.5 trillion while auto debt is $1.1 trillion and credit card debt is close to $1.05 trillion. Furthermore, the US housing dent also hit a record high. In June, the combined mortgage and home equity debt were equal to $9.43 trillion, according to the NY Fed. So far, the rising consumer debt has been supported by low delinquencies, higher property values, rising wages, and low unemployment. However, a slowdown in the economy paired with higher interest rates can putt his equilibrium at risk.

High Yield and BBB-rated debt is growing

The size of the US corporate debt market has reached $7.5 trillion. The size of the BBB rated debt, which is just one notch above junk status, now exceeds 50% of the entire investment grade market.

Bloomberg pointed out that, in 2000, when BBB bonds were only a third of the market, the corporate net leverage (total debt minus cash and short-term investments divided by earnings before interest, taxes, depreciation, and amortization) was 1.7 times. By the end of last year, the ratio had ballooned to 2.9 times.

Further on, the bond powerhouse PIMCO commented: “This suggests a greater tolerance from the credit rating agencies for higher leverage, which in turn warrants extra caution when investing in lower-rated IG names, especially in sectors where earnings are more closely tied to the business cycle.”

Interest rates

Interest rates were the hot topic of 2018 and will continue to be in 2019. With government debt passing $21 trillion and record high consumer and corporate, it is not a surprise that the market is very jittery to rising interest rates. The Fed hiked its overnight lending rate four times in 2018, to 2.25% – 2.50% level. Subsequently, the 10-year Treasury reached 3.24%, before falling to 2.58% as of January 3rd, 2019. In the meantime, the rates of the 2- and 5-year treasuries started to converge in what is known as inverted yield curve.

2019 Market Outlook. Convergence of interest 10-year, 5-year and 2-year rates  over the last 5 years
Convergence of interest 10-year, 5-year and 2-year rates over the last 5 years

2019 Outlook

The US Economy remains strong despite headwinds from multiple directions. Major macroeconomic factors are in positive territory.

  • Highest corporate earnings growth since 2010, over 25% over the first 3 quarters of 2018
  • The last quarter of S&P 500 EPS growth is expected to be between 12% and 15%
  • Equity valuations reach fair territory after the recent selloff.
  • GDP growth over 3%
  • Record high consumer sentiment
  • End of year holiday shopping is expected to beat all records
  • Record low unemployment
  • Highest wage growth since 2008
  • Business activity remains high
  • Interest rates remain under historical levels
  • Low oil prices will temper inflation and lower business cost

Many economists believe that we are in the last leg of economic expansion. And, some are even predicting a market recession in 2020. However, historically economists and equity have not been an accurate indicator for economic recessions. Realistically speaking it would be very hard to enter an economic downturn from where we are today unless we see a very steep deterioration of government policies and business and consumer spending.

Obviously, at this stage, it is hard to predict the equity markets in 2019. I am looking at three major scenarios, which all have realistic chances of developing.

Scenario 1 (30%)

The bull market continues. The US and China reach a mutually beneficial trade agreement. China commits to relax the rules of US firms conducting business in China and strengthen rules for parent protections. The Fed is more cautious about raising interest rates. Apple’s earnings are not as bad as the market is anticipating. Lower interest rates and oil prices help businesses manage their costs, offset slow down in housing sales and boost consumer spending. The corporate earnings growth beats analyst forecast across the board.

Scenario 2 (20%)

We could see another 10-20% decline in Global Stocks before reaching a bottom. Trump continues to criticize the Fed and interfere in its independence. The government shutdown and political bipartisanship continues without a long-term solution. The Brexit is a disaster. China and the US do not reach a meaningful trade agreement that satisfies the markets. Companies continue to report lower revenue and earnings guidance, and some may start laying off employees.  

Scenario 3 (50%)

Global stocks remain volatile for the first 6 months of the year with major swings in both directions. The equity market becomes extremely sensitive to both positive and negative news.

For long-term investors

The best investment strategy has always been buy-and-hold. Trying to time the market is a bad idea. There are many studies that show timing the market has underperformed a buy and hold strategy in the long run. For example, a long-term investor who bought SPY (SPDR S&P 500 ETF) on January 2nd, 2008 would have more than doubled her investment and achieve a 7.2% total return (price appreciations plus dividends).

If you are uncertain about the markets and achieving your financial goals, seek advice from a fiduciary advisor who has your best interest in mind.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized investment management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

The December market meltdown explained

S&P 500 is down almost -16% so far in the last quarter of 2018. The market rout which started in October continued with a powerful selloff in December. The technology-heavy NASDAQ is down -20%, while the small-cap Russell 2000 dropped nearly -22%.

Despite our strong economy major buyers remain on the sideline and retail investors are looking for a bottom..

In my previous article, I talked about the perfect storm that started the market drop in October. Since then more negative news continued to bombard the markets. The markets do not like uncertainty.

Here are some of the factors that triggered fears across the sellers.

  1. Apple stopping to report iPhone sales
  2. FedEx reporting lower guidance for 2019
  3. The resignation of General Mattis
  4. Government shutdown
  5. Failing Brexit negotiations
  6. Trump criticizing the Fed
  7. The recent arrest of Huawei CFO and three Canadians in China
  8. The price of oil dropping to $43.
  9. Yield curve inversion
  10. Growin fears for an upcoming recession
  11. The dominance of electronic and algorithm trading
  12. Low trading volumes due to the holiday season

The combination of more negative news and low trading volumes created yet another perfect storm for what we observed in December 2018.

The asset classes performance

2018 will remain in history as the year when holding cash was the only profitable strategy.  Almost all major asset classes are in the red for 2018.

Future Outlook

As I mentioned earlier, all major macroeconomic factors are in a positive territory.

  • Highest corporate earnings growth since 2010
  • GDP growth over 3%
  • Record high consumer sentiment
  • End of year holiday shopping is expected to beat all records
  • Record low unemployment
  • Highest wage growth since 2008
  • Business activity remains high
  • Interest rates stay under historical levels
  • Low oil prices will temper inflation and business cost

Many economists believe that we are in the last leg of economic expansion. Moreover, some are even predicting a market recession in 2020. However, there is an old joke that the markets have predicted 9 out of the past 5 recessions. In spite the fact that equity markets are forward-looking, they have not been an accurate indicator for an economic recession.

Realistically speaking it would be very hard to enter recession from where we are today unless we see a very steep deterioration in 2019.

The law of mean reversion.

Everything reverts to the mean sooner or later. Last year we had one of the least volatile markets in our recent history. As a result, the S&P 500 standard deviation, a measure of risk, dropped to 3.8% well below average historical levels of 13%. This year’s market volatility is back to these average levels.

Diversify

In any market environment, volatile or not, diversification is essential way to reduce portfolio risk.

Think long term

The best long-term investment strategy has always been buy-and-hold. Trying to time the market is a bad idea. There are many studies that show timing the market would underperform a buy and hold strategy in the long run.

Don’t watch the market every day.

Media skews the news to what is trendy and get more readership.

Use your best judgement.

Panicking has never helped anyone. If you are uncertain seek advice from a fiduciary advisor who has your best interest in mind. 

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

The recent market volatility – the tale of the perfect storm

The recent market volatility – the tale of the perfect storm

The recent market volatility – the tale of the perfect storm

October is traditionally a rough month for stocks. And October 2018 proved it.

S&P 500 went down -6.9% in October after gaining as much as 10.37% in the first nine months of the year. Despite recouping some its losses in early November, the market continues to be volatile with large daily swings in both directions. On top of that, Small Cap stocks which were leading the way till late September went down almost 10% in the span of a few weeks.

So what lead to this rout?

The market outlook in September was very positive. Consumer sentiment and business optimism were at a record high. Unemployment hit a record low. And the market didn’t really worry about tariffs.

I compiled a list of factors which had a meaningful impact on the recent market volatility. As the headline suggested, I don’t believe there was a single catalyst that drove the market down but a sequence of events creating a perfect storm for the equities to go down.

IndexQ1 2018Q2 2018Q3 2018Q3 YTD 2018Oct – Nov 2018Nov 2018 YTD
S&P 500 Large-Cap (SPY)-1.00%3.55%7.65%10.37%-4.91%5.45%
S&P 600 Small-Cap (IJR)0.57%8.69%4.87%14.64%-9.54%5.09%
MSCI EAFE (VEA)-0.90%-1.96%1.23%-1.62%-7.06%-8.68%
Barclays US Aggregate Bond (AGG)-1.47%-0.18%-0.08%-1.73%-0.81%-2.54%
Gold (GLD)1.73%-5.68%-4.96%-8.81%1.39%-7.42%
Source: Morningstar

1. Share buybacks

The month of October is earnings season. Companies are not allowed to buy back shares as they announce their earnings. The rationale is that they possess significant insider information that could influence the market in each direction. As it turned out, 2018 was a big year for share buybacks. Earlier in the year, S&P estimated $1 trillion worth of share buybacks to be returned to shareholders. So, in October, the market lost a big buyer – the companies who were buying their own shares. And no one stepped in to take their place.

The explosion of share buyback was prompted by the TCJA law last year which lowered the tax rate of US companies from 35% to 21%. Additionally, the new law imposed a one-time tax on pre-2018 profits of foreign affiliates at rates of 15.5% for cash and 8% for non-cash assets. Within a few months, many US mega-cap corporations brought billions of cash from overseas and became buyers of their stock.

2. High valuations

With the bull market is going on its ninth year, equity valuations remain high even after the October market selloff.

Currently, the S&P 500 is trading at 22.2, above the average level of 15.7. Its dividend yield is 1.9%, well below the historical average of 4.34%.

Furthermore, the current Shiller PE Ratio stands at 30.73, one of the highest levels in history. While the traditional Price to Earnings ratio is calculated based on current or estimated earning levels, the Schiller ratio calculates average inflation-adjusted earnings from the previous ten years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio) or PE10.

Current Shiller PE Ratio: 2:00 PM EST, Tue Nov 13
Current Shiller PE Ratio:
2:00 PM EST, Tue Nov 13

Source: http://www.multpl.com/shiller-pe/ 

While a coordinated global growth and low-interest rate environment had previously supported the thesis that high valuation ratios were justified, this may not be the case for much longer.

3. The divergence between US and international stocks

The performance of International Developed and Emerging Market remains disappointing. While the US markets are still in positive territory, International Developed and EM stocks have plunged by -8% and -15% respectively so far in 2018.  Higher tariffs imposed by the US, negative Brexit news, growing domestic debt in China, and slower GDP growth in both the Eurozone and China have spurred fears of an upcoming recession. Despite attractive valuations, international markets remain in correction territory, The dividend yield of MSCI EAFE is 3.34%, while MSCI EM is paying 2.5%, both higher than 1.9% for S&P 500.

4. The gap between growth and value stocks

The performance gap between growth and value stocks is still huge. Growths stocks like Apple, Amazon, Google, Visa, MasterCard, UnitedHealth, Boeing, Nvidia, Adobe, Salesforce, and Netflix have delivered 10% return so far this year. At the same time value strategies dominated by Financials, Consumer Staples and Energy companies are barely breaking even.

IndexQ1 2018Q2 2018Q3 2018Q3 YTD 2018Oct – Nov 2018Nov 2018 YTD P/E Ratio
S&P 500 Large Cap Growth (IVW)1.81%5.17%9.25%16.97%-6.95%10.01%29.90
S&P 500 Large Cap Value (IVE)-3.53%1.38%5.80%3.26%-2.59%0.67%19.44

 

5. Tempering earnings growth

So far in Q3 2018, 90% of the companies have announced earnings. 78% of them have reported better than expected actual earnings with an average earnings growth rate of 25.2%. 61% of the companies have reported a positive sales surprise. However, 58 companies in the S&P 500 (12%) have issued negative earnings guidance for Q4 2018. And the list of stocks that tumbled due to cautious outlook keeps growing – JP Morgan, Facebook, Home Depot, Sysco, DR Horton, United Rentals, Texas Instruments, Carvana, Zillow, Shake Shack, Skyworks Solutions, Michael Kors, Oracle, GE, Cerner, Activision, etc.

Despite the high consumer optimism and growing earnings, most companies’ CFOs are taking a defensive approach. Business investment grew at a 0.8% annual rate in the third quarter, down from 8.7% in the second quarter. This was the slowest pace since the fourth quarter of 2016.

The investment bank Nomura also came out with the forecast expecting global growth to slow down. Their economists predicted that global growth in 2019 would hit 3.7% and temper to 3.5% in 2020 from 3.9% in 2018. According to Nomura, the drivers for the slowdown include waning fiscal stimulus in the U.S., tighter monetary policy from the Federal Reserve, increased supply constraints and elevated risk of a partial government shutdown.

 

6. Inflation is creeping up

Almost a decade since the Credit Crisis in 2008-2009, inflation has been hovering below 2%. However, in 2018, the inflation has finally made a comeback. In September 2018, monthly inflation was 2.3% down from 2.9% in July and 2.7% in August.

One winner of the higher prices is the consumer staples like Procter & Gamble, Unilever, and Kimberly-Clark. Most of these companies took advantage of higher consumer confidence and rising wages to pass the cost of higher commodity prices to their customers.

7. Higher interests are starting to bite

After years of near-zero levels, interest rates are starting to go higher. 10-year treasury rate reached 3.2%, while the 2-year rate is slowly approaching the 3% level. While savers are finally beginning to receive a decent interest on their cash, CDs and saving accounts, higher interest rates will hurt other areas of the economy.

10 year versus 2 year treasury rate

With household debt approaching $13.4 trillion, borrowers will pay higher interest for home, auto and student loans and credit card debt. At the same time, US government debt is approaching $1.4 trillion. Soon, the US government will pay more for interest than it is spending on the military.  The total annual interest payment will hit $390 billion next year, nearly 50 percent more than in 2017, according to the Congressional Budget Office.

The higher interest rates are hurting the Financial sectors. Most big banks have enjoyed a long period of paying almost nothing on their client deposits and savings accounts. The rising interest rates though have increased the competition from smaller banks and online competitors offering attractive rates to their customers.

We are also monitoring the spread between 2 and 10-year treasury note, which is coming very close together. The scenario when two-year interest rates go above ten-year rates causes an inverted yield curve, which has often signaled an upcoming recession.

8. The housing market is slowing down

Both existing and new home sales have come down this year.  Rising interest rates, higher cost of materials, labor shortage and high real estate prices in major urban areas have led to a housing market slow down. Existing home sales dropped 3.4% in September coming down for six months in a row this year. New building permits are down 5.5% over 2017.

Markets have taken a negative view on the housing market. As a result, most homebuilders are trading at a 52-week low.

9. Fear of trade war

Some 33% of the public companies have mentioned tariffs in their earnings announcements in Q3. 9% of them have negatively mentioned tariffs. According to the chart below, Industrials, Information Technology, Consumer Dictionary, and Materials are the leading sectors showing some level of concern about tariffs.

Companies Citing Tariffs Compared to Q2 2018

10. Strong dollar

Fed’s hiking of interest rates in the US has not been matched by its counterparts in the Eurozone, the UK, and Japan. The German 10-year bund now yields 0.4%, while Japanese 10-year government bond pays 0.11%. Combining the higher rates with negative Brexit talks, Italian budget crisis and trade war fears have led to a strong US dollar reaching a 17-month high versus other major currencies.

Given that 40% of S&P 500 companies’ revenue comes from foreign countries, the strong dollar is making Americans goods and services more expensive and less competitive abroad. Furthermore, US companies generating earnings in foreign currency will report lower US-dollar denominated numbers.

11. Consumer debt is at a record high

The US consumer debt is reaching 4 trillion dollars. Consumer debt includes non-mortgage debts such as credit cards, personal loans, auto loans, and student loans. Student loans are equal to $1.5 trillion while auto debt is $1.1 trillion and credit card debt is close to $1.05 trillion. Furthermore, the US housing dent also hit a record high. In June, the combined mortgage and home equity debt were equal to $9.43 trillion, according to the NY Fed.

The rising debt has been supported by low delinquencies, high property values, rising wages, and low unemployment. However, a slowdown in the economy and the increasing inflation and interest rates can hurt US consumer spending.

12. High Yield and BBB-rated debt is growing

The size of the US corporate debt market has reached $7.5 trillion. The size of the BBB rated debt now exceeds 50% of the entire investment grade market. The BBB-rated debt is just one notch above junk status. Bloomberg explains that, in 2000, when BBB bonds were a mere third of the market, net leverage (total debt minus cash and short-term investments divided by earnings before interest, taxes, depreciation, and amortization) was 1.7 times. By the end of last year, the ratio had ballooned to 2.9 times. Source: Bloomberg

Further on, the bond powerhouse PIMCO commented: “This suggests a greater tolerance from the credit rating agencies for higher leverage, which in turn warrants extra caution when investing in lower-rated IG names, especially in sectors where earnings are more closely tied to the business cycle.”

13. Oil remains volatile

After reaching $74.15 per barrel in October, US crude oil tumbled to $55, a 24% drop. While lower crude prices are pushing down on inflation, they are hurting energy companies, which are already trading in value territory.

According to WSJ, the oil’s rapid decline is fueling fears for global oversupply and slowing economic growth. Furthermore, the outlook for supply and demand shifted last month as top oil producers, began ramping up output to offset the expected drop in Iranian exports. However, earlier this month Washington decided to soften its sanctions on Iran and grant waivers to some buyers of Iranian crude—driving oil prices down. Another factor pushing down on oil was the strong dollar.

14. Global political uncertainty

The Brexit negotiations, Italian budget crisis, Trump’s threats to pull out of WTO, the EU immigrant crisis, higher tariffs, new elections in Brazil, Malaysian corruption scandal and alleged Saudi Arabia killing of a journalist have kept the global markets on their toes. Foreign markets have underperformed the US since the beginning of the year with no sign of hope coming soon.

15. The US Election results

A lot has been said about the US elections results, so I will not dig in further. In the next two year, we will have a divided Congress. The Democrats will control the house, while the Republicans will control the Senate and the executive branch. The initial market reaction was positive. Most investors are predicting a gridlock with no major legislature until 2020. Furthermore, we could have intense budget negotiations and even another government shutdown. Few potential areas where parties could try to work together are infrastructure and healthcare. However, any bi-partisan efforts might be clouded by the upcoming presidential elections and Mueller investigation results.

In Conclusion

There is never a right time to get in the market, start investing and saving for retirement. While market volatility will continue to prevail the news, there is also an opportunity for diligent investors to capitalize on their long-term view and patience. For these investors, it is essential to diversify and rebalance your portfolio.

In the near term, consumer confidence in the economy remains strong. Rising wages and low unemployment will drive consumer spending. My prediction is that we will see a record high shopping season. Many of these fifteen headwinds will remain. Some will soften while others will stay in the headlines.

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

Market Outlook October 2018

Overview

The US stock market was on an absolute tear this summer. S&P 500 went up by 7.65% and completed its best 3rd quarter since 2013. Despite the February correction, the US stocks managed to recover from the 10% drop. All major indices reached a series of record highs at the end of August and September.

IndexQ1 2018Q2 2018Q3 2018YTD 2018
S&P 500 Large-Cap (SPY)-1.00%3.55%7.65%10.37%
S&P 600 Small-Cap (IJR)0.57%8.69%4.87%14.64%
MSCI EAFE (VEA)-0.90%-1.96%1.23%-1.62%
Barclays US Aggregate Bond (AGG)-1.47%-0.18%-0.08%-1.73%
Gold (GLD)1.73%-5.68%-4.96%-8.81%
Source: Morningstar

 

The US Economy remains strong

Markets have largely shrugged off the trade war fears benefiting from a strong economy and high corporate earnings.

US Unemployment remains low at 3.9% in July and August, levels not seen since the late 1960s and 2000.

Consumer sentiment is at a multi-year high. The University of Michigan Consumer Sentiment Index hit 100.1 in September, passing 100 for the third time since the January of 2004.

Business optimism hit another record high in August.  The National Federation of Independent Business’ small business optimism index reached the highest level in the survey’s 45-year history. According to NFIB, small business owners are planning to hire more workers, raise compensation for current employees, add inventory, and spend more on capital investments.

A hypothetical 60/40 portfolio

A hypothetical 60/40 index portfolio consisting of 30% US Large Cap Stocks, 10% US Small Cap Stocks, 20% International Stocks, 33% US Fixed Income and 7% Gold would have returned 3.06% by the end of September.

IndexAllocationReturn
S&P 50030%3.11%
S&P 60010%1.46%
MSCI EAFE20%-0.32%
Barclays USAgg Bond33%-0.57%
Gold7%-0.62%
Hypothetical Performance3.06%

 

US Equity

I expect a strong Q4 of 2018 with a record high holiday consumer and business spending. While stock valuations remain elevated, robust revenue and consumer demand will continue to drive economic growth.

After lagging large-cap stocks in 2017, small-cap stocks are having a comeback in 2018. Many domestically focused publicly traded businesses benefited massively from the recent corporate tax cuts, higher taxes on imported goods and healthy domestic demand.

This year’s rally was primarily driven by Technology, Healthcare and Consumer Discretionary stocks, up 20.8%, 16.7%, and 13.7% respectively. However, other sectors like Materials, Real Estate, Consumer Staples, Financials and Utilities are either flat or negative for the year. Keep in mind of the recent reshuffle in the sector classification where Google, Facebook, Netflix and Twitter along with the old telecommunication stocks were added to a new sector called Communication services.

Sector performance

SectorPerformancePrice perPrice toDividend
YTDEarningsSalesYield
as of 10/3/2018(TTM) (TTM)(%)
Communication Services-1.91%22.6x1.3x4.83%
Consumer Discretionary13.72%16.5x1.0x1.27%
Consumer Staples-5.50%15.1x1.0x2.86%
Energy8.67%14.0x1.2x1.74%
Financials0.29%15.2x2.1x1.91%
Health Care16.71%18.2x1.2x1.86%
Industrials4.73%15.7x1.1x1.85%
Information Technology20.86%14.8x2.1x0.90%
Materials-3.56%13.2x1.1x1.79%
Utilities0.77%17.1x1.3x3.70%
Source: Bloomberg

 

I believe that we are in the last few innings of the longest bull market. However, a wide range of sectors and companies that have largely remained on the sidelines. Some of them could potentially benefit from the continued economic growth and low tax rates.

International Equity

The performance gap between US and foreign stocks continues to grow. After a negative Q1 and Q2, foreign stocks recouped some of the losses in Q3. Furthermore, emerging market stocks are down close to -9% for the year.

Bad economic data coming from Turkey, Italy, Argentina, Brazil, Indonesia, South Africa, and China along with trade war fears put downward pressure on foreign equity markets. Additionally, rising right-wing sentiments in Italy, Austria, Sweden, Hungary, and even Germany puts doubts on the stability of the European Union and its pro-immigration policies.

In my view, the risk that the financial crisis in Turkey, Argentina, and Italy will spread to other countries is somewhat limited. However, the short-term headwinds remain, and we will continue to monitor these markets.

Brexit

Another major headline for European stocks is the progress of the Brexit negotiation. While soft Brexit would benefit both sides, a hard exit could have a higher negative impact on the UK.

I remain cautiously positive on international stocks. According to WSJ, foreign stocks are trading at a 12% discount over US equity on price to earnings basis. This year created value opportunities in several counters. However, the issue with European and Japanese stocks is not so much in valuations but the search for growth catalysts in conservative economies with an aging population.

Fixed Income

Rising Fed rates and higher inflation have driven bond prices lower so far this year. With inflation rate hovering at 2%, strong employment figures, rising commodity cost, and robust GDP growth, the Fed will continue to hike interest rates. I am expecting one more rate hike in December and three additional hikes in 2019.

I will also continue to monitor the spread between 2-year and 10-year treasury. This spread is currently at 0.23%, the lowest level since 2005.  Normally, a negative spread, i..e 2-year treasury rare higher than 10-year is a sign of a troubled economy.

While modest, individual pockets of the fixed-income market are generating positive performance this year. For instance, short duration fixed income products are now yielding in the range of 1.5% to 2%. The higher interest is now a compelling reason for many investors to keep some of their holdings in cash, CDs or short-term instruments.

With 10-year treasury closing above 3% and moving higher, fixed income investors will continue to see soft returns on their portfolio.

Gold

Gold is one of the big market losers this year. The strong dollar and robust US economy have led to the precious metal sell-off.  While the rise cryptocurrency might have reduced some of the popularity of Gold, I still believe that a small position in Gold can offer a buffer and reduce the overall long-term portfolio volatility. The investors tend to shift to Gold during times of uncertainty.

Navigating market highs

With S&P 500, NASDAQ and Dow Jones hitting all-time highs, how should investors manage their portfolio?

Rebalance

End of the year is an excellent opportunity for reconciliation and rebalancing to your target asset allocation. S&P 500 has returned 16.65% in the past five years, and the chance that equities are taking a big chunk of your portfolio is very high. Realizing some long-term gains and reinvesting your proceeds into other asset classes will ensure that your portfolio is reset to your desired risk tolerance level as well as adequately diversified.

Think long-term

In late January and early February, we experienced a market sell-offs while S&P 500 dropped more than 10%. Investors in the index who did not panic and sold at the bottom recouped their losses and ended up with 10% return as of September 30, 2018. Taking a long-term view will help you avoid the stress during market downturns and allow you to have a durable long-term strategy

 

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

Market Outlook April 2018

Market Outlook April 2018

Market Outlook April 2018

After a record high 2017, the volatility has finally returned. Last year the market experienced one of the highest risk-adjusted performances in recent history. In 2017 there were only 10 trading where the S&P 500 moved by more than 1% in either direction, with not a single trading day when it moved by more than 2%. In contrast, in the 61 trading days of Q1 of 2018, we had 26 days when the S&P 500 moved by more than 1% and 8 days where it changed by more than 2%.

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VIX Index Q1 2018

Market Outlook April 2018
VIX index Q1 2018. Source Yahoo Finance

The VIX Index, which measures the volatility of the S&P 500 started the year ar 9.77. It peaked at 37.33 and ended the quarter at 19.97.

Markets do not like uncertainty, and so far, Q1 had plenty of that. In the first 3 months of the year market landscape was dominated by news about rising inflation and higher interest rates, the Toys R Us bankruptcy, trade war talks and tariffs against China, and scandals related to Facebook user data privacy.

Except for Gold, all major market indices finished in the negative territory.

IndexQ1 2018
S&P 500-1.00%
Russell 2000-0.18%
MSCI EAFE-0.90%
Barclays US Aggregate Bond Index-1.47%
Gold+1.73%

 

Fixed Income

Traditionally bonds have served as an anchor for equity markets. Over time stocks and US Treasury bond have shown a negative correlation. Usually, bonds would rise when stocks prices are falling as investors are moving to safer investments. However, in 2018 we observed a weakening of this relationship. There were numerous trading days when stocks and bonds were moving in the same direction.

On the other hand, despite rising interest rates, we see the lowest 10-year/2-year treasury spread since the October of 2007. The spread between the two treasury maturities was 0.47 as of March 29, 2018. While not definite, historically negative or flat spreads have preceded an economic recession.

Momentum

Momentum remained one of the most successful strategies of 2018 and reported +2.97%. Currently, this strategy is dominated by Technology, Financials, Industrials, and Consumer Cyclical stocks. Some of the big names include Microsoft, JP Morgan, Amazon, Intel, Bank of America, Boeing, CISCO, and Mastercard.

Value

Value stocks continued to disappoint and reported -3.73% return in the Q1 of 2018. Some of the biggest names in this strategy like Exxon Mobile, Wells Fargo, AT&T, Chevron, Verizon, Citigroup, Johnson & Johnson, DowDuPont and Wall-Mart fell close to or more than -10%. As many of these companies are high dividend payers, rising interest rates have decreased the interest of income-seeking investors in this segment of the market.

Small Cap

As small-cap stocks stayed on the sideline of the last year’s market rally, they were mostly unaffected by the recent market volatility.  Given that most small-cap stocks derive their revenue domestically, we expect them to benefit significantly from the lower tax rates and intensified trade war concerns.

Gold

Gold remained a solid investment choice in the Q1 of 2018. It was one of the few asset classes that reported modest gains. If the market continues to b volatile, we anticipate more upside potential for Gold.

 

Outlook

  • We anticipate that the market volatility will continue in the second quarter until many of the above issues get some level of clarification or resolution.
  • We expect that small and large-cap stocks with a strong domestic focus to benefit from the trade tariffs tension with China and other international partners
  • The actual impact of lower taxes on corporate earnings will be revealed in the second half of 2018 as Q3 and Q4 earnings will provide a clear picture of earnings net of accounting and tax adjustments.
  • Strong corporate earnings and revenue growth have the ability to decrease the current market volatility. However, weaker than expected earnings can have a dramatically opposite effect and drive down the already unstable markets.
  • If the Fed continues to hike their short-term lending rates and inflation rises permanently above 2%, we could see a further decline in bond prices.
  • Our strategy is to remain diversified across asset classes and focus on long-term risk-adjusted performance

 

If you have any questions about your existing investment portfolio or how to start investing for retirement and other financial goals, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

 

Biggest Risks for the Markets in 2018

Biggest Risks for the Markets in 2018

Biggest Risks for the Markets in 2018

Wall Street is gearing for another record year on the equity market. On January 2nd Nasdaq crossed 7,000. A day later S&P 500 reached 2,700. Dow Jones followed by passing over 25,000. Who can ask for a better start?

However, with S&P 500 earning +22% and Nasdaq gaining 32% in 2017, many are wondering if the equity market has any fuel left for another big run. With momentum on its side, the recent corporate tax cuts, and president’s promises for deregulation we have the foundation for another record high year. But not everything is perfect. In times of market euphoria, investors tend to ignore warning signals.

Surely, there is no shortage of potential threats that can trigger another significant market correction or an economic recession. In my view, here are the biggest risks for the market in 2018 and beyond.

Learn more about our Private Wealth Management services

Government shutdown

With the start of the year, both Republicans and Democrats are gearing for a battle as the current government funding bill expires on January 19.

Republicans are invigorated after winning their most important battle of 2017. The GOP voted for the most extensive tax overhaul in 30 years which promises to cut taxes for corporations and middle class but also introduces additional $1.5 trillion to the budget deficit in 10 years without counting for growth. Their 2018 agenda includes cutting entitlements, building a border wall, financing a new infrastructure plan, increasing the military budget and maybe repealing Obamacare.

On the opposite end, after their win in the Alabama senate race, Democrats are slowly recovering from their knockdown phase after the US 2016 Presidential election.  Democrats will try to push their agenda on the Dreamers Act and save the government healthcare subsidies.

With a slim Senate majority and traitorous rifts inside the party, the GOP will have a hard time passing any significant legislation. The Senate leadership already expressed their desire to work with Democrats on the next bill on avoiding a government shutdown. While the public may appreciate a bi-partisan agreement, both parties have shown an enormous resistance to compromise on any level.

Geopolitical crisis

There is a growing number of geopolitical threats that can compromise the global growth. The world is becoming a treacherous place where one miscalculation can lead to a human disaster. From cyber-war with Russia to nuclear tension with North Korea, ongoing unrest in the Middle East, shutting down NAFTA, populist governments taking over Europe, and hard Brexit negotiations.

China is looking to fill the vacuum left by the US after scrapping the Trans-Pacific Trade Agreement.  Russia and President Putin want to play a bigger role in the world affairs. The remnants of ISIS are spread around the world and planning the next terrorist attack. The 16-year war in Afghanistan is still going with no resolution in sight. The tension between Iran and Saudi Arabia is on its highest level for years. The president must maneuver carefully in the dangerous waters of world politics where governments are becoming more and more protectionist and populist.

Health Care Chaos

The GOP was unsuccessful in repealing the Affordable Care Act. However, they were able to remove the individual mandate as part of the recent tax cut bill.

With the penalty going away in 2019, there will be no incentive for healthier individuals to sign up for health insurance.  Furthermore, this will lead to a lower number of insured participants and drive higher their cost of health care.

US has already the most expensive health care among all OECD counties. The average cost per individual in the USA is $10,000 versus $6,700 for Switzerland and $5,100k for Germany. The Congress and Senate must find a solution to address the climbing health care cost. The alternative will lead to more healthy people dropping from the system, skyrocketing medical bills, social unrest,  and even economic slowdown.

Retail meltdown

US retail is in danger. In 2017, 19 retailers including Toys R US, Aerosoles, Perfumania, True Religions and Gymboree filed for bankruptcy protection. Many others like Teavana, Bebe, and Kenneth Cole closed all their physical locations to focus on online expansion. Despite rising consumer confidence and record-high holiday shopping spree, traditional brick-and-mortar retailers are struggling to stay afloat.

Apart from a few big names, US retailers are loaded with debt. According to Bloomberg, $100 million of high-yield retail debt was set to mature in 2017. Furthermore, this figure will rise to $1.9 billion in 2018 and will average $5 billion between 2019 to 2025. With rising interest rates and permanent drift towards online shopping, many retailers will continue to close down unprofitable locations. Local economies relying heavily on retail jobs will suffer high unemployment rates in the coming years.

Consumer debt crunch

The US household debt has reached $13 trillion in the third quarter of 2017, according to the New York Fed. Driven by low-interest rates, the mortgage debt increased to $8.7 trillion. Student debt has reached $1.36 trillion. Auto loan debt is $1.2 trillion. While mortgage delinquencies are stable at 1.2%, bad auto loans have risen to 2.4%, and student debt delinquencies have reached 9.6%.  The rising interest rates can lead to more people failing on their loans, which can potentially trigger another crisis similar to 2008.

Interest hikes and hyperinflation

The US fed is planning for three rate hikes in 2018. Oil has slowly passed $60 a barrel. And US dollar reached 1.20 against the euro. Moreover, U.S. manufacturing expanded in 2017, as gains in orders and production capped the strongest year for factories since 2004.  While around the world factories have warned they are finding it increasingly hard to keep up with demand, potentially forcing them to raise prices.

While CPI hovers around 1.7%, global markets have not priced in the prospects for higher inflation. Therefore, unexpected spike in prices can lead to more Fed rate hikes.

Additionally, the lost corporate tax revenue can jeopardize the ability of the US Treasury to issue debt at lower rates, which can drive the budget deficit even further. Historically, uncontrolled inflation combined with growing budget deficit has led to periods of hyperinflation, higher credit cost and loss of purchasing power.

Retirement savings going down

Only half of US families have a retirement account. The 401k plan patriation is only 43%. Of those with retirement savings, the average balance is just $60,000. Social Security ran $39 billion deficit in 2014 and will be entirely depleted by 2035.

With rising interest rates and GOP plans to cut entitlements, many Americans will face enormous retirement risk and suffer substantial income loss during their non-working years. Without an urgent reform, the US social security system is a time-ticking bomb that can hurt both businesses and families.

Mueller investigation

The former FBI chief investigation is at full speed as more revelations about the Trump campaign appear almost on a daily basis. You might need a crystal ball to predict what will be the exact outcome. However, it is virtually certain that there were people in the Trump circle who were pursuing their own personal interests. The initial theory of collusion and obstruction of justice is leading to allegations about money laundering. If the Mueller investigation proves those accusations, we could experience a political crisis not seen since Watergate.

 

About the author: Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm. Babylon Wealth Management offers highly customized Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans and other institutional clients. To learn more visit our OCIO page here.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing, Photo copyright: <a href=’https://www.123rf.com/profile_bacho12345′>bacho12345 / 123RF Stock Photo</a>