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May 28 2019 
Stocks, Bonds, Risk & Return
Will The Trade War Further Diminish Economic Growth?
Investors have witnessed a number of strange occurrences in recent months, if not years. Though stocks have staged a big rally this year (most of it in January), this has merely been an attempt – unsuccessful as of yet – to recover from 2018’s 20% decline that stocks experienced towards year’s end. Even more interesting and odd is the fact that stock prices are lower today than they were in January 2018 – over 16 months ago! What gives? Why are stocks stuck in this long trading range and when will markets allow us to get back to making significant long term returns?
Source: Bloomberg Global stock markets are tied to economic growth and corporate profits. One need look no further than 2017 as a reminder – a period when economic growth exceeded 3%, corporate profits skyrocketed and stock indexes and your portfolio of stocks soared upwards of 20%. Those were the days!
However, as we review the past few quarters, economic growth rates have decelerated from over 3% to something closer to 2% or less. The Atlanta Federal Reserve Bank GDPNow model’s most recent estimate is that the US economy is growing at just a 1.3% annual rate in the current quarter. And the Atlanta Fed’s model is not alone: the Economic Cycle Research Institute runs a historically reliable Weekly Leading Index that also shows the US economy is slowing to a stall.
Lastly, the decline in long term US Treasury yields (lowest level in 2 years) and falling commodity prices are signs that the economy is not on solid ground. Investors would be wise to keep these facts in mind.
The slowdown in global and US growth is largely attributable to the Federal Reserve’s rate hikes in 2018 which in turn led the punishing 20% decline in stocks. Add to that the month-long US government shutdown and the now real effects of tariffs and it is plain to see why the economy has drifted to a slower pace. In the meantime, it is quite clear that corporate profit growth is feeling the effects of this slowdown.
Though some companies such as MasterCard, Unilever, and NextEra have been able to generate respectable growth in this slowing economy, many others have missed earnings growth expectations – most specifically in sectors that are sensitive to the economy such as the industrial and consumer discretionary sectors. If the economy continues to slow – or more importantly recede (as in recession) – earnings and stock prices could be in for a further downside slide. Therefore, the key to managing your way through a slower economy is to make sure your portfolio has companies that can generate profits regardless of the economy and also be flexible about your level of stock exposure.
Just because the economy has slowed doesn’t mean that the market needs to spiral into a wicked bear market (more than the last 20% decline). If the economy can maintain this slower than normal growth rate, there are plenty of companies you can add to your portfolio to potentially make handsome profits this year, particularly in the healthcare, select technology, financial and consumer staples sectors.
As you know, in an effort to put the odds in your favor for a good year of performance, we have been patiently waiting for stock prices to experience a normal correction after the big rebound in January. That correction appears to be underway as of this writing (~4% off high) – this should give you great opportunity to add more stock exposure in companies that can generate profits in this slower than normal part of the economic cycle. Of course, if the correction appears to be gaining steam on the downside (which would probably be due to negative news about the economy, profits or further tariffs) I may suggest you slow such purchases. Remember: when economies – particularly those threatened by tariffs – are weak, stocks can really take it on the chin.
Throughout history stocks go up about 80% of the time – however, the 20% of the time stocks are not going up is usually tied to the economy – and this time appears to be no different. The stock market doesn’t deliver consistent year-to-year returns and never has. The important part for investors is to dodge the grizzly bear markets (declines of 35-60%).
Successful long term investing takes patience and discipline and a keen eye for what the market has done recently (in this case nothing for almost 18 months); and as well an eye for where the economy and profits will take us as we go forward. Once this period of economic weakness stabilizes or even contracts, we could have many years of bull markets and profits to look forward to in the “80% of the time” mode. The stock and real estate markets have been and, as far I can see, will continue to be the best places to grow wealth over the long term.
Protecting capital in bear markets allows you to reach your long-term goals, whether those goals are to retire, meet your organization’s spending policy guidelines or leave a greater legacy for the next generation. In that spirit, continue to monitor the global economy, the effects of continued tariffs and to manage the risk of your portfolio through your allocation to stocks, sector management and the use of carefully placed stop-loss orders.
I hope this update finds you well and that you enjoyed the Memorial Day Weekend.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
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May 16 2019 
James Demmert Gives Back!
A Tiburon resident since 1990, James was honored as 2018-19 “Citizen of the Year” for his longstanding support of, not only the Tiburon chamber and its community events, but many local, county and national organizations.
James and his company, Main Street Research, have found many ways to give back to the community. Every quarter, Main Street gives a percentage of its profits to a charity. These have included the Susan G. Komen for the Cure, Marin Food Bank, USO, World Villages for Children, American Lung Association and the Leukemia & Lymphoma Society.
On the Tiburon peninsula, James is a supporter of many charities and schools, has been a sponsor of the Chamber’s Friday Nights on Main since its inception and donated 40 flat-screen monitors to the Belvedere-Tiburon Library as well as giving back to the Tiburon Landmarks Society. It is also one of the first financial services firms to receive the Bay Area Green Business designation for running a truly green business.
For the past 10 years, Main Street Research has had an internship program for college students, giving them the opportunity to “test the waters” of an investment firm. “Some of them love it and go on to work in the business,” James says, “ and others decide it’s not for them – and that’s o.k., too. This is one way I can pay it back.”
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
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May 14 2019 
Why Many Nonprofits and Public Charities Fail to Survive
Many nonprofits and public charities fail to survive – at a time when their need is unquestionable
As an investment manager, I have witnessed time and time again that nonprofits lack focus on long-term financial sustainability. A critical challenge faces all nonprofits and charities—how to remain financially sustainable.
Research indicates that about one in eight nonprofits fails within five years and one in five fails within ten years. The boards of nonprofits usually put a lot of their focus on fundraising, but this neglects their other responsibility – how to invest their endowment so it won’t deplete over time.
The use of nonprofit organizations to address social and environmental problems is increasing. The National Center for Charitable Statistics (NCCS) reports that in 2018, there were 1.56 million tax-exempt 501(c)(3) nonprofit organizations registered in the U.S. The majority of these (1.09 million) are public charities – organizations to which the public donates contributions. The remainder includes private foundations, and other types of nonprofit organizations, including chambers of commerce, fraternal organizations and civic leagues.
Nonprofits spend a great deal of time and effort fundraising each year, but many do not maximize the value of their endowment by investing it wisely. This wastes their resources and increases the risks that they simply run out of money if their fundraising declines over time.
The number of nonprofit organizations has been increasing in recent years. This is attributed to many factors, including a recognition that the world faces many social and environmental problems that governments do not have money to address.
Millennials have a keen interest in getting involved in nonprofit sector work, but often do not have the financial or executive experience necessary to do the proper planning for revenue development and long- term survival.
Many organizations exist to help nonprofit boards of directors learn leadership, planning, and financial management skills. I especially recommends that once a nonprofit reaches the $500,000 endowment mark, they formalize an Investment Policy document and begin working with an investment manager who can assist them with endowment investment decisions. This step is also necessary to ensure that boards of directors fulfill their fiduciary responsibilities to their stakeholders.
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The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come. This book walks you through the basics and best practices of what you need to know to be successful.
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Apr 24 2019 
Global Stock Indexes Return to Previous Highs: What a Short Strange Trip It’s Been
The recent recovery in global stock prices has been astonishing and is of historic proportion. Investors would be very hard-pressed to recall a period when stock prices have ever made such a big percentage round trip – both down and back up – in such a short period of time. The reasons for the global sell-off have been well chronicled: Federal Reserve rate hikes, slowing economic growth and corporate profits, the US government shut down, and tariff wars to name a few. Though these were – and are – legitimate concerns, why have stock prices shrugged these risks off? Is this the beginning of another significant, multi-year leg higher for global equity prices? Maybe.
One thing we know for sure is that stock markets serve as a discount mechanism to future events. Stocks have an uncanny way of rising just ahead of better news or falling prior to the darkest part of dawn. That is why it is often best to buy stocks when the economy is at its worst – or when the list of worries is as long as it was during the first quarter. The other thing I know about stock prices is that shorter-term movements – months, not years – are often driven by investor psychology – not necessarily fundamentals.
Fear and greed can move stock prices quite significantly in both directions, as we have seen in the past six months. Is the recent volatility, both up and down, a sign that the market is discounting better news about the economy going forward? Or is it just a massive bout of investor fear and greed? I would suggest a bit of both, which means we should be careful but more opportunistic during any upcoming market corrections and put the odds in your favor for a good year of investment performance.
It is pretty easy in hindsight to look back over the past three months of this recovery and think that only a fool would have been cautious during such a period. I tend to take a more “safe than sorry approach” when the key pillars of stock market strength – economic growth and corporate profits – look as vulnerable as they have in the past six months. Often times “cracks” in these important pillars bring on treacherous bear markets and catastrophic declines (40-50%) in stock prices – i.e. 2001, 2008. These types of bear markets occur about every 9-10 years and can ruin a healthy financial/wealth plan or an endowment’s spending policy. Investors would be wise to keep that statistic in mind, should one think that risk management is a fool’s game.
As you know, you have had less stock exposure than normal during this period to mitigate the potential of a further slide in stock prices. This more cautious stance (less stock) has temporarily muted your upside. However, the difference between your return and the market would be easily rectified if we had a normal market correction of 7-9% which is – in my opinion, and that of other bright investment experts – way overdue.
The laundry list of worries that we faced at year’s end has dissipated. The Federal Reserve has made a key pivot to be more accommodating while the economy looks to have slowed, but maybe stabilizing at the current lower growth rate of 1.5-2% annually. This, in turn, may allow corporate profits to meet already lowered expectations. You can make great profits in a slower-growing economy by tilting your portfolio to companies that can deliver consistent growth.
Given the fact that things look a bit brighter, you should continue to add stock where you see great value. If we do experience the way overdue, much anticipated, normal market correction you should most likely speed up such purchases to get your portfolio more in line with market returns.
Though one might be tempted to add back any missing stock exposure now, or within days, I would suggest a more patient approach to yield the best returns over the longer term. If the economy is truly on a slower, but solid growth path, there will be better opportunities over the coming weeks and months to be fully invested.
Though the skies appear to be a bit brighter and the clouds are dissipating, we are in the thick of corporate profit reporting for the first quarter. This may bring some disappointments and a return to volatility on the downside. Should profits and economic data experience a further decline, we will continue to manage this risk by adjusting your portfolio’s allocation to stocks, your sector exposure and the use of carefully placed stop-loss orders.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
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Apr 01 2019 
Patient and Value Conscious: Upcoming Data Should Align Stock Prices and the Economy
Long-term investment success often requires short-term periods of patience, restraint and being value-conscious. In today’s fast-paced, short-term performance, the digitally-driven world this can be a challenging combination. However, the discipline to step away from short-term “noise” and carefully examine the “forest” as opposed to the “trees” can result in significantly better long-term returns. This can often mean going against the crowd in the face of a falling or rising market.
Years ago I learned that short-term movements in equity markets are driven by psychology, but long-term trends are driven by economic and corporate profit growth. This comes to mind during the past few months as I witnessed the dichotomy of sharply rising stock prices in the face of declining economic growth and corporate profits. Investors need to ask at this point which of the two – the recent direction of stock prices (up) or corporate profits (down) – has greater longevity? And, how will this play out over the next few months and the balance of the year?
In just a few weeks, stock prices appear to have lost their momentum. In fact, for most of March, global stock indexes were in the red. At the same time, economic statistics and corporate profit reports have continued to deteriorate. Perhaps the long-term fundamentals are beginning to trump short-term psychology? I believe that this may be the case. The bond market, which has historically been the best predictor of such things, appears to agree.
This is evidenced by the bond market’s recent yield curve inversion – short-term yields higher than long-term yields. This unusual phenomenon often precedes weaker economic data and profits. A bit more time, along with earnings and economic data in April, should bring the disparity between stock prices and underlying fundamentals back in line.
We faced the beginning of a bear market in the fourth quarter of 2018 with most indexes down 20% and many sectors down much more. Though we don’t predict Armageddon for the global economy or stock market, we also do not believe that a real bull market can begin again without at least a normal correction or perhaps something worse. We may be on the precipice of such a move given that the market has lost its momentum and we are heading into what is likely to be a dismal period of earnings reports and economic statistics from the first quarter when the US Government was shut down. For that reason, we continue to be a bit more defensive than your normal, fully invested portfolio.
I suggest you continue to search for and take advantage of isolated opportunities in companies that represent great value regardless of the market’s direction. These are difficult to find and, given the overall market environment, the pace of adding significant exposure has been slow.
It is always difficult to predict with accuracy the direction of stock prices, but one simple rule holds true: When the economy and corporate profits are rising, stocks do great! That has just not been the case over the past 4 months, which poses a risk to investors. As a reminder to anyone who has experienced a normal bear market, stocks typically fall before the bad news about profits as happened in October – and then have sporadic, often significant, advances as we’ve seen recently – only to decline again into poor earnings reports.
Though global stocks historically decline approximately 40% during an average bear market, I am not predicting such an outcome. In fact, be ready to become more growth-oriented as soon as stock prices and earnings growth are more aligned – most likely when stock prices are lower and most of the bad news about profit growth has been digested. I wouldn’t be surprised to see this come to fruition in the next few months.
After decades of managing money, I have experienced a number of these short-term periods of being less invested and they have proven to be a bit trying in the middle, but valuable in the end. None of those past periods lasted more than months and I don’t expect this period to be an exception.
Write caption… The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
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Mar 26 2019 
Charitable Giving: Changes to Tax Laws May Change How You Gift Going
I actively give back to local and global charities through my company and I know many of you do as well. In that spirit, I wanted to provide you with some changes that have been put into place regarding tax laws that may affect the way you gift to your favorite non-profits. If you are a non-profit, it is good to keep up with changing tax laws when asking for support.
With the 2017 Tax Jobs Act, many more taxpayers will be using the standard deduction instead of itemizing. As a result, individuals who are used to charitable write-offs may no longer see a tax benefit from their contributions. This puts contributing to Donor Advised Funds (DAFs) and Qualified Charitable Distributions (QCDs) in a new light.
Donor-Advised Funds (DAFs)
You may also consider front-loading your charitable contributions while compounding your charitable impact, by contributing to a Donor-Advised Fund (DAF). One of the biggest advantages of a DAF from a strategic tax planning perspective is their flexibility: you make donations to the account and receive immediate tax benefits for doing so.
You receive the deduction in the year the contribution is made, with no expiration on when the contribution must be made to the charity of choice. In fact, there is currently no set time frame during which you must pay out the funds. The donation you make can grow in the donor-advised fund account indefinitely or be distributed right away. Think of this as your charitable savings account where donors can contribute to the fund as frequently as they like and make grants to their favorite charity when they are ready.
Donor-advised funds, like Schwab Charitable, – the 6th largest in the world – are recognized by the IRS as a tax-exempt public charity or 501(c)(3), thus are eligible to receive tax-deductible charitable contributions. However, donations to DAFs are not eligible as a QCD.
Additionally, the 2017 Tax Jobs Act created higher standard deductions for taxpayers, making it less efficient to write off charitable donations. Instead of donors bunching their donations every other year to get over the standard deduction threshold and causing a feast or famine cycle for charities they can qualify for a current year, itemized deduction and grant to charities on their own timetable by donating to a DAF.
DAFs might be useful for people who want to donate appreciated stock, mutual funds, exchange-traded funds, or other securities.
Assets generally accepted include:
- Cash equivalents
- Publicly traded securities
- Certain restricted, controlled, or lock-up stock
- Mutual fund shares
- Bitcoin shares
- Private equity and hedge fund interests
- Real estate
- Certain complex assets, such as privately held C- and S-Corp shares
Donor-advised fund tax deductions include up to 60% of adjusted gross income for cash donations and up to 30% for securities. Whether the donation is securities, cash or both, you must itemize in order to take the deduction.
Qualified Charitable Distributions (QCDs)
Individuals claiming the standard deduction can still get a tax break for giving to charity, just so long as they are 70½ or older and transferring the funds from a traditional IRA directly to a qualified charity.
The QCD allows an individual to transfer funds from a traditional IRA directly to a qualified charity without the money being added to their adjusted gross income. If you are 70 ½ and have not yet taken your Required Minimum Distribution (RMD) for the year, then it can count toward your RMD for that year.
One of the most important caveats is that these distributions must be made directly to a qualifying charity. If it is distributed to an individual taxpayer first, then it will be considered a taxable event.
Many brokerage firms now allow individuals to order checks on their IRA accounts so that checks can be written and mailed directly to these charities. This is very convenient; however the taxpayer must be certain that the charity has cashed the check before the end of the year.
Always get a receipt from the charity for tax reporting purposes. The charity must be a 501(c)(3) organization. Individuals, private foundations and donor-advised funds do not qualify as recipients. There is also a cap on the amount that can be gifted income tax free each year at $100,000 ($200,000 for spouses filing jointly).
If neither of these options suit your gifting needs, please keep in mind you may gift up to $15,000 ($30,000 for spouses) per individual recipient in 2019. These gifts can be made tax-free either by check, transfer of funds, wire transfer or direct deposit into a 529 account.
Here’s to happy giving!
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
-
Mar 19 2019 
Market Rise Driven by Speculation…Not Positive Data
My Strategy for a Good Year Regardless
The recent advance in stock prices has been stellar and has caught most investors by surprise. The biggest mystery surrounding the recent rally is the lack of any signs that the economy or corporate profit picture is improving. In fact, during the last two months, economic data points both here and abroad continue to show signs of slower than expected growth, while corporate profit growth targets have been unable to meet previously lowered guidance.
If economic growth and corporate profits drive stock prices (which is how it’s always been) how can one explain the market strength in recent months? Is the stock market indicating that the recent global slowdown will be over sooner than we think? Or is the recent rally based on overly enthusiastic investors simply participating in an all-too-common case of chasing stock prices in a bear market rally? Let’s take a look at both scenarios and provide you with an update on my strategy going forward, and why I am optimistic about your portfolio’s performance as the year progresses.
As a reminder investing aggressively in the face of a significantly slowing economy and deteriorating corporate profit environment is risky business. It is during these types of circumstances that investors have historically been hurt most – think of past bear markets (2008 or 2001) that started in a similar fashion – hence our more careful approach in recent months.
Was all of the “bad news” already in the price of stocks back at the December lows?
We are just weeks away from corporations reporting their earnings for the first quarter of this year, which should be very telling. Included in this data will be the impact of the long US government shutdown and the negative affect it had on consumers and business spending during those three months. These upcoming profit reports will likely be worse than the previous quarter, and far worse than comparisons to a year earlier. Maybe the recent market strength is a sign that both upcoming and future reports will not be as bad as originally suspected?The Federal Reserve appears to be much more accommodating which is supportive for the market. Historically, stock markets often begin rising before profit growth improves (speculation by investors) and it is possible that we are witness to such a phenomenon at this point. If that is the case the market lows of December would not need to be revisited and the bull market will continue to be alive and well for now. Over the next few weeks, I will be watching earnings and economic data points for confirmation that this is in fact true. If that is the case, I plan to use any temporary weakness in stocks to become more invested.
A normal market correction is way overdue
Both bullish and bearish professional investors agree that we are way overdue for a normal correction in stock prices after such a strong rally and we should use that weakness (combined with a more supportive outlook) as an opportunity to reinvest. Upcoming negative earnings reports will probably be the catalyst of a normal correction. A normal correction (8-10%) would provide an opportunity for our performance to get back in line with markets (I am looking forward to that!) and set us up for a strong and profitable year.It is possible that all the bad news hasn’t been fully priced into stocks
The alternative and less optimistic case to the one described above is that stock prices at current levels are not priced correctly (too high) for the upcoming (negative) data on both economic growth and earnings. In this scenario, stock prices would adjust downward, most likely closer to the lows of December and possibly lower. Though the recent market strength is encouraging, stock prices have failed to reach previous highs and, in some sectors, are nowhere near those levels.From a purely technical level (looking at charts) the market has struggled in recent weeks to make any serious progress which may be a sign of an upcoming correction or perhaps something worse. As I have reminded investors, bad or “bear” markets don’t take long – months not years – but average declines are close to 40%. I want to ward against this type of loss by advising you be less invested as you are today, but also take advantage of the great bargains that become available after bear markets, which your more defensive posture will allow you to do.
It isn’t easy being less invested during a temporarily rising market. However, historically, the outcomes have sided with patience.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
-
Feb 13 2019 
Global Stocks Rally Off Lowest Levels: Is It Safe to be Fully Invested?
Over the past six weeks, global stocks have staged a significant comeback. After being down nearly twenty percent in late December (bear market territory), indexes have climbed half-way back to their previous highs (see chart below). Much of this recent gain can be attributed to the Federal Reserve being more sensitive to what is now obvious: the global economy has been decelerating along with corporate profits, neither good for stock prices.
In addition to the Fed’s accommodation, there is swirling speculation (mostly optimistic) that another US government shutdown and harmful trade negotiation outcome can be averted. I have taken a more defensive position during the past few months – which can be trying given the most recent upward trending market. Is the recent market strength a sign that “all is well” and we should be once again fully invested (up to your asset allocation)? Or is the recent strength just a temporary “relief” rally to be followed by a decline? Let’s look at some data points.
MSCI World Stock Index (1 year) Short Term Trends and Fiduciary Responsibility
Although the recent market strength is welcome, investors should be careful about assuming that short term price movements dictate the health of the underlying economy and corporate profits. Short term (weeks) movements in stock prices should also not be used to predict the health or future direction of stocks, as tempting as it may be. For instance, a decline in stocks during a bull market can appear to lead one to consider selling, just as a temporary rise in stocks in an unhealthy market can lead one to go “all in” – both bad ideas.In my view, investors would be best served by confirming that the basic fundamentals of a healthy economy and stock market justify being fully invested in the stock market.
The Slowing Economy and Profits Picture
If the global economy can slow down to a consistent “cruising speed” of 2% annually and the Fed stays accommodative, we believe that – with corrections along the way – stocks can go higher this year.However, at this point, the downtrend in economic growth and earnings has not shown signs of slowing. Today, for instance, the big industrial company Caterpillar warned of weaker than expected sales. In my view, a continuation of weaker than expected economic statistics and profits can easily send markets lower and your first priority for your assets is to mitigate significant downside risk. I will be watching all the data points in the coming days and weeks for signs of stability.
Trade, D.C., Brexit, etc.
Each of these factors played a role in the market’s decline and subsequent recent market strength – depending on nothing but short term speculation. Investors would be wise to consider the potential negative impact that these events could have on the health of the economy. I will also be watching these data points over the course of the coming days and weeks.Is Recent Market Strength Sustainable? Is a Market Correction Overdue?
In a bull or bear market, stock indexes have periods of short term strength (rallies) and weakness (corrections). Interestingly the recent strength in stocks has not been accompanied by any clarity on the issues discussed above, except for positive Federal Reserve commentary. The strength, however, has been significant and has reached a point by many measures I consider to be overextended. So yes, a correction or decline in stock prices is probably overdue at this point.Should You Buy Shares in Great Companies During the Next Market Correction?
If the economy and profits appear to be on better footing and trade and government shutdown risks dissipate, the answer is YES. A moderate stock market correction, with better fundamentals, would remove recent underperformance and allow you to buy some of the world’s best companies at great prices. On the other hand, in the face of continued deterioration in market fundamentals, continue the tact of keeping “safer than sorry.”A Profitable 2019
It is important to recall those periods of tough economic climate and bad markets are not long affairs (months not years). In my view the stock market will soon – if it already hasn’t done so – discount the worst-case scenario for the economy and corporate profits, leaving you plenty of time to make great strides in growing your wealth during the course of the year ahead and the many years beyond.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
-
Jan 22 2019 
“Should I Stay or Should I Go Now”
Is Recent Stock Market Strength a Sign of Safety…or Danger?
Since early October there has been a “bear market” in stocks, both here and abroad. Though some indexes declined approximately 20% from their highest point, most stocks were down much more until just recently. In the past few weeks, stock indexes have rallied about 10% providing some relief for investors, but far from the peak reached in late September.
This is a good time to explore if the recent strength in indexes is the beginning of a better stock market or just a short-term advance leading to further trouble ahead. As you know we have kept your portfolio defensive during this period, with less stock exposure and less volatile stocks. Though this is effective during market declines, it can be a bit trying in the face of the recent market strength.
How can we determine if there is further downside ahead or if the recent rally is the beginning of a real recovery? Let’s review the data points that were the cause of the tough market. In my view, we need these data points to stop trending downward or to become more clarified, before we take a more “risk on” growth posture.
Economic Data
The economy and stock market are co-dependent. The first sign of economic weakness at the end of the third quarter is what sent stock prices into the downward trajectory. Since that time most leading economic indicators continue to be in a downtrend. Investors need global economic growth to stabilize stock prices to stage a meaningful long-term recovery. If economic growth can stabilize – albeit at a lower rate – stocks could still do very well and better than most investment alternatives. However, we need to see clearer signs of stability on this front.Corporate Profit Growth
Economic growth is directly tied to the profitability of companies both here and abroad. We are now at the beginning of earnings season and need to see companies meeting or exceeding the lowered expectations that analysts have adjusted downward since the fourth quarter. Some of the most recent warnings and reports have not been positive, including Apple, JP Morgan, Macy’s and Ford – all of which have been negative.However, the earnings season has just begun and we have some big bellwether companies reporting over the next few weeks including domestic heavyweights Boeing and Caterpillar. These upcoming reports should shed further light on the sustainability of the market’s recent advance.
Lastly, when it comes to earnings reports, it is very important that investors realize that these reports are about what happened last quarter and are not a precursor to what may happen going forward. This is why we also want to consider the following three policy challenges. These policy issues need to be better clarified before markets can be on more sound footing.
Federal Reserve (Fed) Policy
The Fed has raised rates nine times over the past two years in an effort to prevent the economy’s growth (inflation) from accelerating too quickly. As we have written before, this effort comes with the risk that the Fed can mistakenly “overshoot” their estimate of interest rate increases versus growth and turn an otherwise sound economy into a recession.This concern is real and is one of the reasons investors have been selling shares. Fortunately, the Fed has recently backed away from being so adamant about further rate hikes. In the short run, this has soothed investor’s fears. However, I would like to see further clarity in the Fed’s message and a willingness to reverse course if necessary. The next Fed meeting at the end of this month may provide this.
Global Trade Policy
Tariffs and other impediments to trade with China and other global trading partners are a negative for global and domestic growth. On this front “no news is bad news.” Economic data from China is slowing and they remain an important trading partner for the US and global economy. A trade deal that turns out to be better than earlier perceived would go a long way to alleviate investor fear and support both economic growth and global corporate profitability. We will be watching these negotiations carefully.
Government Shut Down
Though short-term government closures have been stock market nonevents in the past, we are now in uncharted waters. Previous government shutdowns have been measured in days while this one is now more than a month old. This has a negative effect on a number of sectors of the US economy and some of our country’s largest corporations. Investors would be wise to consider the shut down as a further risk to stock prices. As with the other policy challenges, any sign of improvement or positive outcome to this standoff would be supportive of a better stock market environment.Clearly, there is no shortage of bad news and challenges on the domestic and global front – for the sake of brevity, we left Brexit and US debt levels out of the discussion. At times the stock market “discounts” all of the bad news by lowering the price of shares. We are not sure that the stock market has fully priced in some of these current risks, particularly given the more recent elevated level of share prices. However, if it turns out that the recent strength is the beginning of the recovery – coupled with some clarity on the issues described above – a re-test or normal correction from these levels would be expected, allowing us an opportunity to invest at more attractive prices in the very near future.
Keep in mind that bear markets often demonstrate periods of short term strength which are followed by declines back to the old lows or even lower. This was the case with the market rally in November that resulted in a further 10% decline in indexes. If this recent strength is just another temporary rally in the bear market – given that all major indexes still remain in long-term downtrends – I want to make sure your assets are safe. In that spirit, I continue with my recent, ongoing mantra of “better to be safe than sorry” when it comes to the bulk of your liquid net worth. Keep in mind that historically bear markets last just 6-8 months and this one is already entering its fourth month. Over the next few weeks and months I will be continuing to monitor the data points and view any pullback in stock prices as a possible re-entry point, but one that will need to be validated by better fundamentals.
I am excited about the prospect of re-investing in a significant global stock market recovery.
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Jan 02 2019 
Global Stock Markets Face Fork in the Road: Is the Worst Over?
2018 can best be described by Charles Dickens who wrote, “It was the best of times, it was the worst of times.”
Within the backdrop of strong economic data and corporate profitability, global equity markets advanced well into September, only to give back all of the gain – and then some – ending the year with all major indexes in the red.
The media quantifies a bear market as a decline of 20% or more, and most major indexes have either surpassed that threshold or are within striking distance. For all intents and purposes, I would classify this as a bear market. The question investors should be most concerned with is: is it a gentle bear market or a more aggressive grizzly? Let’s take a look at some data points.
As I mentioned in my last Strategy Update, the market is approaching a fork in the road and the direction it takes will be dependent on economic data. The road to the left (gentle bear) goes in a direction where we find that most of the decline in stock prices is behind us.
This road will be full of signposts that argue the global economy will continue to grow, albeit rather slowly, and avoid a recession. These economic data points released in the coming weeks will allow me to get some verification. One of the mile markers will be stronger than expected earnings. Earnings season starts this week, so I will be paying close attention to these reports.
Finally, a more constructive stock market environment requires significant policy expertise. This relates to a more accommodative Federal Reserve, progress in tariff negotiations and lastly, but not least important, getting our government turned back “on.”
From my perspective, the data points on earnings and the economy are easy to judge. However, I think the market’s biggest problem is the unknown of potential policy missteps. I am hopeful economic and earnings data are supportive and that policy makers can successfully navigate these issues. If some or none of these data points yield positive results, we are more than likely going to be traveling down the other, much less forgiving, fork in the road (grizzly bear).
In the absence of supportive economic data and/or policy success, I believe that global stocks could easily decline further. If one considers that the average bear market decline is approximately 38%, it is easy to see how much worse this could get for investors. Down this road are signposts that earnings are worse than expected and the economy is teetering on recession.
That alone could be enough to send stocks down another leg, but combined with a policy error could really solidify the grizzly bear case. Though bear markets can be difficult, keep in mind that they are not long affairs – usually just 6-9 months – which means we may be a good way through this one. The best thing about a bear market is that when they end there are tremendous bargains to take advantage of if investors have the cash and capital to do so.
It is impossible to know which fork in the road the market will take. Anyone who says they know for sure would be mistaken. To quote Jack Bogle, the veteran Vanguard CEO, this week in Barron’s magazine, “This is no time to take significant risk and if anything investors should reduce risk at these levels.”
I strongly agree with Mr. Bogle.
If at the present time the bulk of your assets are in fixed income, they will be generating better than money market return. I do not see this as a long term investment strategy, but a very good safe harbor until we get better clarity on the issues ahead of us.
In your taxable account, you may have taken some significant capital gains from selling some of your big stock winners in recent years. These sales on balance were timely as many stocks are much lower today and now your portfolio is more defensive. However, with the gains come capital gains taxes. Keep in mind my thoughts that it is better to pay thousands in taxes, than to lose millions in market value. Your tax liability will be about one-third of the total realized capital gains, which for most amounts to about 2-3% of their total portfolio value – a small price to pay for portfolio protection.
I wish you and your families a very Happy New Year!
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