Autumn 2017 State of Investments
Brian Kilb: You know Kyle, if you look in the third quarter in the context of the whole year so far, the narrative looks pretty similar, right? We had strong earnings, which have led to strength in domestic stocks, a weaker dollar I think, which has contributed to some strong results in overseas markets. The emerging markets have reemerged, as it were.
The bond market, I think, has held up better than we would perhaps have expected at the beginning of the year.
Kyle Tetting: Yes Brian, great start to the year, continued that run in the third quarter here. The S&P up a little more than 4.5%, when you include dividends. Really, just adding to what had been, a pretty good first half.
You know, if the rest of the world’s economies start to catch up in the way that we hope they will, it won’t be so much that the dollar can weaken because – or the dollar can strengthen because – of our economy. It’ll be the relationship between our economy and the rest of the world that really starts to drive that relationship.
Brian: We get so many questions from clients regarding how did we put together this great year so far? And the answer’s pretty fundamentally simple, as it relates to interest rates and earnings. The third factor that we go back to, though, and look at it in terms of stock performance is valuations. That story is not as appealing right now and may present some challenges as we look ahead.
Kyle: Absolutely, Brian. You look at what had been, for the longest time, markets that were incredibly cheap. That story’s just not there anymore. We can’t say that things are cheap anymore. I think the one thing that’s supported that is that we have a very low hurdle rate. You don’t need potential for high returns to beat what is a pretty low expectation for returns on bonds because the 10-year Treasury rate’s so low.
And ultimately, that’s kind of what we’re measuring against. We look at what could we get on a stock versus what could we get on a bond. Yes, stocks are much more expensive now than they have been, but when you look at the alternatives – especially the really safe alternatives – it still does make sense to be a stock investor. Although, I think the story has changed a little bit, and you need to be a little bit more cautious.
Brian: I think a lot of people going into the year might have thought the bond market would have been a little rocky or a little more challenging. And here we are. It’s held up really well through three quarters of the year.
Kyle: Yes. I think we just haven’t seen inflation reach the Fed’s target, and that’s ultimately what’s going to allow the Fed to continue to raise the overnight rate and to continue with their plan of reducing the size of their balance sheet. And those are the kinds of things that long term can have an impact on rates on the longer end of the yield curve.
Obviously, the Fed’s going to move very cautiously there, though, and for investors, it’s a really good thing.
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As a bond investor, I really want to keep my safe money in the safe assets, and only when I’m being paid to take that risk, do I want to take an increased risk in my, in my safe money.
Again, right now we’re just not seeing that. With inflation fairly low and probably going to stay low here for a little while, it seems like bonds could continue on a pretty steady path here for at least a little while.
Brian: Kyle, let’s talk about the end of the year and things that may be a bit of a challenge. Certainly, any type of surprise in corporate earnings or interest rates will unsettle markets. Where might the other challenges come from in the short term?
Kyle: I think there has been an incredibly low amount of volatility right now, and it reflects the fact that investors just really haven’t had a lot of concern about the direction of the economy. They haven’t had a lot of concern about the direction of corporate earnings. And of course, interest rates haven’t really put a lot of concern in investors’ minds.
And so, I think the lack of concern has been reflected in that volatility. But more importantly, because of these incredible runs higher that we’ve had – runs higher without really big up and down days but just a lot of very slow movement higher – I think the risk is that we do get that surprise that ultimately causes markets to react in a way that is going to be less favorable for investors. But again, I think it can come from just about anywhere.
Brian: And I hate to say that something has to happen because it hasn’t happened in a while, but it’s unlikely that we’ll see this kind of low volatility last forever.
Kyle: It’s very common to have, at the very least, a 10% correction in markets every year – something we haven’t seen in about a year and a half.
All the signs point to continued slow growth, and yet, now’s a great time to take some profits. Now’s a great time to make sure that you’ve funded those distributions that you know you’re going to need for the next few years. Because ultimately, we don’t know what’s going to happen. As investors, we have to operate under the assumption that anything could, and so you take what you can get, when you can get it.
Brian: And I think part of that, Kyle, is just what are the opportunities for us to gain by being more aggressive versus the opportunities for us to protect ourselves, should things get a little more volatile? And I don’t see a lot of opportunity for taking more-than-normal risk.
I like to get paid when I take risk. And really, the case for that is not as strong as perhaps the case that things could get a little choppy
So, I agree with you. It’s a great time to be a little more conservative maybe, to take some profits and to look for opportunities in the future to find places where there’s good value and good long-term potential, which doesn’t exist right now in many ways.
Brian Kilb is president and chief operating officer of Landaas & Company.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Money Talk Video by Jason Scuglik and Peter May.
Investing amid synchronized global growth, a Money Talk Video with Marc Amateis
Valuing Investments: Price-Earnings Ratio, a Money Talk Video with Dave Sandstrom
Earnings Yield: Valuing Stocks vs. Bonds, a Money Talk Video with Kyle Tetting
Federal Reserve Holdings: What to know, a Money Talk Video with Marc Amateis
The ups and downs of volatility, a Money Talk Video with Steve Giles
(initially posted Oct. 13, 2017)
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