As the dust settles on the busiest week of Q4 earnings, there is a pretty clear pattern emerging in terms of the market’s responses. As you might expect at a time when “risk” is a dirty word and the Dow looks set for its worst month since 2009 and the Nasdaq its worst January ever, traders seem to be working on a
When the markets seem scary, it’s tempting to wait for a “better” time to invest. History suggests this may be a mistake. Many investors feel nervous about making a commitment to equities, particularly following robust periods of market performance. There are always economic clouds on the horizon, and no one wants to envision their investments taking an immediate loss. But trying to “time the market” by waiting for a more opportune time to invest may be a mistake, as time horizon has often been a significant factor in long-term market results. We would all time the market if we could do it successfully. Who wouldn’t want to avoid major market declines or fully participate in a bull market? The problem is that market timing requires one to make decisions that even professionals find difficult, if not impossible. This is not to say that considering the overall direction of the markets and making tactical tilts aren’t without merit. Trying to time one’s overall exposure to the equity market, however, brings with it a new set of risks, and may ultimately derail an investor’s long-term goals and objectives. The Pitfalls of Timing Individual investors are notoriously bad at picking the right times to invest. Fund flows show that investors tend to move in and out of the market at precisely the wrong time – in essence, buying high and selling low. In 2008 and 2009, for example, during the depths of the bear market, investors pulled significant assets out of equity funds. Several years later, they moved back into equity funds just as many equity indexes were approaching or had surpassed old highs (see Figure 1). Figure 1: Market Timing Travails Source: Strategic Insight Simfund MF, FactSet. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. In fact, the patterns of overall equity market returns are one of the reasons that market timing is so difficult. Market increases have often come in spurts, and missing some of the market’s best days could have a significant impact on returns, as those days have historically accounted for a surprising portion of the market’s overall annual returns (see Figure 2). Figure 2: Impact of Missing Equity Market’s Best Days S&P 500 10 Years Ending October 21, 2015 Source: FactSet. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Over Time, Stocks Have Tended To Go Up Over extended periods of time, the U.S. stock market has tended to rise in value. Consider Figure 3, which shows that the S&P 500 has risen in 75% of all one-year time periods since reliable market data began (in 1926). Over longer periods, the percentage of positive outcomes has also increased as well – for example, there has been no 15- or 20-year period in the S&P 500’s history in which the index has registered a negative return. Figure 4 shows the S&P 500’s performance over rolling 10-year periods (that is, the 10-year periods ending in 1935, 1936, 1937 and so on). In only two instances – ending in the depths of the Great Depression and in the midst of the global financial crisis – did the S&P 500 produce negative returns after a 10-year holding period. We believe this underscores the importance of maintaining a long-term perspective. Figure 3: The Percentage of Positive S&P 500 Outcomes Has Varied by Holding Period Source: FactSet. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Figure 4: Benefits of Long-Term Investing S&P 500 10-Year Rolling Returns Source: FactSet. Data as of October 31, 2015. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Managing Risk Through Diversification Of course, the case for any given asset class only goes so far. Maintaining diversification is another way to help mitigate the downside risk of an overall portfolio. Investors have often relied on a mix of stocks and investment-grade bonds for this reason. In the current low-yield environment, however, we favor diversification across a broader asset allocation framework that reaches beyond traditional equities and fixed-income to enhance diversification against broad market risk. Investors today also have access to a broader array of investment options that can provide diversification benefits. For example, once the province of institutions and wealthy individuals, alternative investment strategies are now increasingly available in vehicles without investor qualification restrictions. So-called “liquid alternative” funds are retail mutual funds that pursue alternative investment strategies. Adding alternatives strategies to a portfolio of traditional equity and bond investments can help lower correlations to equity and fixed-income markets. Given the significantly expanded range of alternative strategies available today to a broad audience, adding the potential diversification benefits of non-traditional approaches has become a simpler exercise. Climbing The Wall Of Worry Over time, the stock market has managed to navigate periods of economic crisis and geopolitical uncertainty and has overcome significant market pullbacks. Although the global economy continues to expand at a moderate pace, helped by the stimulative efforts of central banks, the proverbial wall of worry stands high today. The Federal Reserve’s potential tightening cycle, China’s slowing growth trajectory, weak commodity markets and elevated valuations are just a handful of concerns that have investors pondering a move to the sidelines. The angst investors feel in the current environment is understandable, and behavioral tendencies can be difficult to resist. Working with a financial advisor can provide investors with a long-term perspective and help them make decisions based on goals, objectives and risk tolerance rather than emotion. This material is provided for informational purposes only. Nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The views expressed herein are generally those of Neuberger Berman’s Investment Strategy Group (ISG), which analyzes market and economic indicators to develop asset allocation strategies. ISG consists of a team of investment professionals who consult regularly with portfolio managers and investment officers across the firm. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. Certain products and services may not be available in all jurisdictions or to all client types. Indexes are unmanaged and are not available for direct investment. Unless otherwise indicated, returns shown reflect reinvestment of any dividends and distributions. Neuberger Berman LLC is a Registered Investment Advisor and Broker-Dealer. Member FINRA/SIPC. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.
Are corporations in great shape? Three consecutive quarters of declines in earnings suggest that they are not. Worse yet, record high leverage coupled with close-to-record low interest coverage indicate stress within corporate balance sheets. Beginning with the “profit recession,” it has become fashionable to describe the deterioration as a function of the price collapse in oil and gas. However, that assessment fails the sniff test on three different levels. One, six of the ten S&P 500 economic segments share in the year-over-year earnings contraction, not the energy sector alone. Second, if one excludes energy as an outlier on the negative side, one would be obliged to throw away super-sized contributors like healthcare on the positive side of the ledger. In doing so, the profit picture still appears weak. A third reason that it is foolish to dismiss energy earnings? Analysts made the same mistakes prior to the economic downturns in 2001 and 2008. It was short-sighted to toss the technology sector in the dot-com collapse. It was irrational to exclude financials in the banking crisis. It follows that it would be just as insular to ignore the influential energy segment when evaluating corporate profitability today. Perhaps more troubling is the erroneous belief that corporations have improved their balance sheets since the Great Recession. In truth, U.S. companies have doubled their total debt levels since 2007, while simultaneously finding it more difficult to pay interest expenses on outstanding obligations. According to Investopedia , the interest coverage ratio determines the ease or difficulty by which a company can service its existing debt. The ratio is calculated by dividing a company’s earnings before interest and taxes (EBITA) by the company’s interest expenses for the same period. The higher the ratio, the less burdened by borrowing costs a company is; the lower the ratio, the more onerous the debt expense is for a company. Now take a look at the charts below. Total leverage by U.S. “investment grade” (IG) corporations has catapulted through the proverbial roof. Leverage does not matter as long as companies can service the debt, right? Unfortunately, investment grade interest coverage is back to levels not seen since 2009. If one shifts to corporations on the world stage, the picture becomes more nebulous. Consider the net debt-to-earnings (EBITA) at global companies. This measure looks at the number of years, theoretically speaking, that a company would require to pay obligations back. And right now, according to Standard & Poor’s, net debt-to-EBITA in 2015 at 3.0 was the highest since 2003. That’s not all. Analysts typically regard a ratio below three as “safe.” With the average global company straddling the fence between safe and not-so-safe, what does that tell investors about the financial health of the world’s corporations? Why should anyone focus on all the debt talk surrounding the world’s corporations? Don’t they always find a way to right their respective ships? Well, for one thing, if a company has money left over after it services its debt obligations, it cannot necessarily expand its business in productive ways, including research, development, human resources acquisition, marketing and so forth. We’ve already seen the most recent reading of the Institute For Supply Management (ISM) Non-Manufacturing Index hit its lowest level since March of 2014 (55.3). That’s not encouraging, even if it shows expansion in the services arena. In a similar vein, it is highly discouraging to witness carnage in the capital goods arena. It would seem that companies are unwilling and/or do not have the discretionary dollars to invest in tangible assets to produce goods or services such as office buildings, equipment and machinery. Maybe debt is taking a nasty toll after all. (See the chart below.) So how might one invest in an environment where corporate and government debts have skyrocketed, asset prices have hit extremes and the Federal Reserve is committed to raising borrowing costs? Former PIMCO “guru” Mohamed El-Arian has finally decided that 25%-30% in cash is the best way to survive what he anticipates will be better buying opportunities down the pathway. For my clients at Pacific Park Financial, Inc., we began making the tactical allocation shift in June of 2015 – seven months ago. We downshifted from 70% growth (e.g., large-cap, smaller-cap, foreign, etc.) to roughly 50% growth (high-quality, low volatility large-cap stocks). We moved from 30% income (e.g., short, long, investment grade, higher-yielding, etc.) to approximately 20%-25% investment grade income. With cash or cash equivalents approximating 25% – safer harbors such as the SPDR Nuveen Barclays Short-Term Municipal Bond ETF (NYSEARCA: SHM ) as well as money market vehicles – we reduced volatility while awaiting better buying opportunities. While I expect the corrective activity that began in May of 2015 to continue, my clients understand that I seek to reduce risk, not eliminate it. It follows that current stock exposure at 45%-50% does not represent a mindset of “shorting” or being out of equities completely. For the most part, we have been out of foreign positions and smaller U.S. companies for quite some time. Nevertheless, we maintain an allocation to equity ETFs via funds like the iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) and iShares USA Minimum Volatility ETF (NYSEARCA: USMV ). The bond story is remarkably similar. Rather than pursue cross-over corporates or high-yield or even long-term investment grade corporates, we have stayed near the middle of the curve with funds like: (1) the SPDR Nuveen Barclays Municipal Bond ETF (NYSEARCA: TFI ), (2) the Vanguard Total Bond Market ETF (NYSEARCA: BND ), (3) the iShares 7-10 Year Treasury Bond ETF ( IEF) and (4) the iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI ). There are those who crave a bit more potential than cash or T-bills. For those folks, rather than “shorting,” we employ multi-asset stock hedging. We’ve picked up some of the assets in the FTSE Multi-Asset Stock Hedge Index , including the yen, gold, and zero-coupon treasuries. Make no mistake about it, however. The cash that had been raised in 2015 has multiple purposes. It provides a measure of comfort when stock volatility surpasses norms. In addition, cash offers one the ability to acquire “buy low” value propositions. Even now, there are folks with excess cash who might want to examine a dividend aristocrat like Aflac (NYSE: AFL ). With a trailing P/E of 10, a forward P/E of 9, a dividend yield of 2.9% and a price from mid-2014, you may decide the rewards are worthy of the risk. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships