Market Review Q2 2018

July 12, 201811 Min Read
Quarterly Market Review

The Positive

Unemployment has stabilized at a near-record low of 4.0%, (As of June 2018; https://data.bls.gov/timeseries/LNS14000000) which should lead to future wage and equity price growth.

The Negative

Authoritarianism continues to spread, which has bred market successes like China, but mostly economically ruinous outcomes like Venezuela.

The Big Gambit

Recent trade disputes could eventually lower costs for global commerce or heighten the recent protectionism that has curbed job and economic growth.

Declines in democratic norms have far outpaced improvements in countries across the globe
Sources: Freedom House, World Bank, U.S. Bureau of Economic Analysis. Contact United Income for more details.
But, global GDP growth has continued its upward trajectory despite these setbacks to democracies
Sources: Freedom House, World Bank, U.S. Bureau of Economic Analysis. Contact United Income for more details.
As expected, recent U.S. tax reform drove down federal tax receipts (in trillions)
Sources: Freedom House, World Bank, U.S. Bureau of Economic Analysis. Contact United Income for more details.
But, spending has not slowed down, causing U.S. federal debt growth to accelerate (in trillions)
Sources: Freedom House, World Bank, U.S. Bureau of Economic Analysis. Contact United Income for more details.

Dispatches from the Desk

Now that volatility has become a more consistent fixture in markets, we often get questions around not just how to invest, but when to invest. Specifically, can United Income time markets to reduce or prevent losses?

Implications for Your Portfolio

One of the age-old investing mirages is the idea that investors can, and should, time their investments to boost returns. Like the fountain of youth was to early global explorers, market timing is one of the most sought-after ideas in finance. Market timing arguments often come in two different flavors: 1) prices are too high, so it’s time to sell or stay on the sidelines and 2) prices are too low, so it’s time to invest.

However, much like those seeking the fabled “Fountain of Youth”, it is a fool’s errand for the average investor to try to time the markets. One way to see this is to consider the performance difference between investing a lump sum of cash today vs. investing that lump sum incrementally over 12 months, a market-timing strategy sometimes referred to as dollar-cost averaging. To assess this, we looked at each month going back to 1976 and found that 83% of the time it was better to invest your full savings today instead of dollar-cost averaging your savings over 12 months. (This analysis examined a portfolio comprised of 60% MSCI World Standard Index (gross) and 40% Bloomberg Barclays U.S. Aggregate Index, rebalanced monthly. In each month from January 1976 to January 2016, the performance difference was compared between investing 100% of the portfolio today vs. investing 1/12th of the portfolio each month. Performance is theoretical and does not reflect trading in actual accounts and is provided for informational purposes to indicate historical performance of the investing approach over the period. . Results are adjusted to reflect the reinvestment of dividends and other income and are presented gross of fees and do not include the effect of transaction costs, management fees, performance fees or expenses. There are no guarantees that a portfolio employing this or any other strategy will outperform a portfolio that does not engage in such strategies. Past performance does not guarantee future results. All investments have inherent risks. There can be no assurance that an investment strategy proposed will by United Income will achieve its goal.) In short, investors would be wrong nearly every year over the past 40 years if they thought they could time markets using that approach.

Another way to see the futility of market timing is to compare the difference between average investor returns, or how the average traded portfolio performed, compared to average investment returns, or how the average portfolio would have performed if it was simply held. In this way, we can assess whether wealth was added or lost by investors trying to outsmart and time the market. Over the past ten years, for instance, average investor returns in U.S. stock portfolios lagged the average investment return by 0.61% per year. Similarly, investors in taxable bond portfolios and those in international stock portfolios lagged average investment returns in those asset classes by 0.88% and 1.04%, respectively. (Russel Kinnel, “Mind the Gap 2018, U.S.”, Morningstar Inc, Jun 12, 2018; https://corporate1.morningstar.com/ResearchArticle.aspx?docu-mentId=867811) In short, investors are almost assured to be their own worst enemy if they strive to build wealth through market timing.

For further proof that market timing is as elusive as Juan Ponce de León’s 16th century search in the Bahamas for youth, consider that full-time professional fund managers get it wrong nearly all of the time as well. One way to see this is that fewer than 1 out of 5 fund managers outperformed the S&P 500 over the last 5 years and those that do rarely repeat that feat. (Aye M. Soe, Ryan Poirier, “SPIVA U.S. Year-End 2017 Scorecard”, S&P Global, Mar 15, 2018; https://us.spindices.com/documents/spiva/spiva-us-year-end-2017.pdf)

Our Verdict

Outguessing markets is a very difficult task, and one that investors have shown little ability to execute well. Fortunately, this is one variable affecting wealth outcomes that investors can control: you are almost assured to be wealthier if you don’t try to time markets.

While we do believe that expected returns across different industries, segments, and countries should vary over time, we find it’s difficult for most investors to profit from this variation by market timing.

Implications for the Economy

Although market timing is foolhardy, it is something that millions of people still do or have done for them by their investment managers. This can carry economic implications, although those effects are increasingly modest.

Probably the most consequential example of this was in the wake of the famous market crash in 1929, which sent the economy into a tailspin. Suddenly scared to invest, large shares of investors instead kept their wealth on the sidelines in the form of cash, sometimes even at home instead of banks. This not only helped cause the Great Depression, but perpetuated it, since commerce in the country stalled without consumers spending and investing their money. U.S. companies soon followed, leading to lower corporate investment rates and crushing economic growth. In response to this spiraling cycle of economic decline, the federal government responded with a host of new public policies to encourage Americans to spend and invest, which resuscitated the economy and have since become a core part of American culture.

But, usually the economic effects of market timing (and the opportunity for dispassionate investors that do not try to time markets) are less dramatic. For instance, recent market volatility is somewhat the result of fund managers at major investment institutions trying to respond to daily trends in consumer sentiment, political posturing, and other market-moving news. Importantly, these efforts to time markets fell short as fewer than half of active U.S. equity fund managers outperformed relevant indices in the first quarter of 2018. (Russell Investments Active Manager Review – Q1 2018; https://russellinvestments.com/us/about-us/newsroom/2018/russell-invest-ments-active-manager-review-q1) But, as we reviewed in the first quarter newsletter, the longer term economic effect of this volatility is limited

Our Verdict

Market timing can have macroeconomic consequences, but it is rare and nearly always marginal. And, in the few times where it has led to substantive economic effects, patient investors can gain major, non-incremental wealth when compared to investors who try to time the market.

Implications for Our Investment Strategy

Given the breadth and depth of data that indicates market timing can be destructive to wealth, we instead strive to take advantage of volatility when it inevitably arises. One way we do this is by trying to reduce your tax bill after prices fall. Every day, our automatic tax-loss harvesting algorithm scans your portfolio for opportunities to sell securities with losses and lock in tax benefits today. Following the sale, we promptly invest the proceeds so your portfolio never skips a beat. This strategy is designed to enable you to build up a reserve of losses that can offset future gains and the taxes these gains will generate. (United Income does not represent in any manner that its tax loss harvesting strategy will result in any particular tax consequence or that specific benefits will be obtained for any individual investor. The tax loss harvesting service is not intended as tax advice. Members should consult their personal tax advisor as to whether tax loss harvesting is a suitable strategy, given the member’s particular circumstances. The tax consequences of tax loss harvesting are complex and uncertain and may be challenged by the IRS or any other tax authority. The internal revenue code, as well as judicial and administrative interpretations of it, are subject to change and could have a material impact on the consequence of United Income’s tax loss harvesting approach.)

Another way we aim to capitalize off of market volatility is by optimizing Roth conversion advice for our members. If you have a traditional IRA, you can convert it to a Roth IRA which is exempt from income and capital gains taxes, but you have to pay income tax on the full traditional IRA balance during the conversion. By converting to a Roth after a market drop, you can save taxes relative to converting beforehand. Our software and team of financial advisors can help evaluate if and when a Roth conversion can benefit your financial plan. These are just two ways that we try to increase your wealth, regardless of what markets throw our way.

Our Verdict

While we do believe that expected returns across different industries, segments, and countries should vary over time, we find it’s difficult for most investors to profit from this variation by market timing. However, that doesn’t stop us from searching for that Fountain of Youth, and new technology that we have invented certainly gives us a renewed sense of hope that we may yet succeed. Until that occurs, though, we will continue to harvest wealth gains for our members from other’s attempts.

If you would like to learn more about our focus on generating wealth for our members in all market environments, please contact your financial advisor today – or call 855-215-3032 (option 1).

Member Results

At United Income, we are always focused on helping our members generate wealth. During periods of market uncertainty, each additional dollar of wealth matters, so we aim to generate wealth from more than just investment returns. By focusing on tax savings, Social Security and Medicare optimization, and keeping costs low, we can generate a more sustainable wealth return for our members.

Here you will find data highlighting the power of this unified approach.

Higher Investment Returns

7 of the 11 equity ETFs that we use to build portfolios in member accounts have outperformed relevant ETF benchmarks over the trailing 12 months. (From 1999 to 2017, the MSCI USA Minimum Volatility Index, MSCI USA Sector-Neutral Quality Index, MSCI USA Momentum Index, MSCI USA Enhanced Value Index and MSCI USA SMID Cap Index have all outperformed the MSCI USA IMI Index, measured using annualized compound return (gross dividends). There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Mutual funds, exchange-traded funds, and other securities are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that an investment strategy proposed will by United Income will achieve its goal. Past performance does not guarantee future results.)

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Lower Taxes

For risk composition scores (Risk composition score ranges from 0-10 and is United Income’s recommended target portfolio for your financial plan. This score can be translated into a percentage mix of stocks and bonds, where a score of 0 represents 100% bonds/0% stocks and a score of 10 represents 100% stocks/0% bonds. Risk Composition Score is a proprietary liabilities-driven investment strategy calculation based on your financial plan inputs. This score depends on your (a) longevity estimates (b) investment strategy for each goal (c) “leftover funds” investment strategy (d) the estimated spending per goal (e) goal ranking and (f) projected income. It also may be dynamic over time, in particular, the score may update based on changes in account balances due to contributions, withdrawals or market fluctuations.) less than 5, the average tax savings (Estimated tax savings are measured as 17.5% x (long-term losses realized) + 24% x (short-term losses realized) across all taxable member accounts. These realized losses are reflective of trades where cost basis information was available and recorded within United Income. These rates reflect a middle-tier of the tax rates that are applicable to members. Individual member tax rates could be higher or lower than the rates we use in our estimated tax savings calculations. Actual tax savings will depend on the specific circumstances of each member and may differ significantly from amounts calculated. United Income does not represent in any manner that its tax loss harvesting strategy will result in any particular tax consequence or that specific benefits will be obtained for any individual investor. The tax loss harvesting service is not intended as tax advice. Members should consult their personal tax advisor as to whether tax loss harvesting is a suitable strategy, given the member’s particular circumstances. The tax consequences of tax loss harvesting are complex and uncertain and may be challenged by the IRS or any other tax authority. The internal revenue code, as well as judicial and administrative interpretations of it, are subject to change and could have a material impact on the consequence of United Income’s tax loss harvesting approach. There is limited authority governing whether an ETF is “substantially identical” to another ETF for the purpose of the wash sale rule. Accordingly, there can be no assurance regarding how the IRS would resolve this question in specific contexts. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Past performance does not guarantee future results. ) for the quarter was 6.6 bps or 0.066%. For risk composition scores greater than 5, the average tax savings for the quarter was 4.3 bps, or 0.043%.

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Lower Fees

The expense ratio for a United Income portfolio of ETFs investing in 60% equity and 40% fixed income is 65% cheaper than the average mutual fund. (Morningstar US Fund Fee Study, 2016. Average mutual fund fee calculated based on the asset-weighted mutual fund fee for a portfolio of 30% US Equities, 30% International Equities, and 40% Taxable Bonds, which is the same allocation a United Income member electing 60% equity and 40% fixed income would receive in their portfolio.)

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On the Horizon

Over the next few months, United Income will be enhancing our approach within fixed income. As always, our goal is to align your investment risk with your risk tolerance. Two risk factors within bonds are duration, or the sensitivity to interest rate changes, and credit, or the sensitivity to potential defaults. Our enhanced approach to bond investing will feature additional ETFs that will personalize exposure to duration and credit based on your financial plan. You will see purchases of new U.S. bond ETFs in your portfolios as we aim to outperform in this rising rate environment.

Performance

As of July 22, 2019
Equity
TRAILING 3 MONTHS
TRAILING 12 MONTHS
VV: Vanguard Large-Cap ETF (benchmark)
3.43%
14.43%
SCHX: Schwab US Large-Cap ETF
3.52%
14.53%
USMV: iShares Edge MSCI Min Vol USA ETF
2.85%
10.72%
QUAL: iShares Edge MSCI USA Quality Factor ETF
1.31%
14.16%
VLUE: iShares Edge MSCI USA Value Factor ETF
1.32%
14.82%
MTUM: iShares Edge MSCI USA Momentum Factor ETF
4.12%
24.72%
VB: Vanguard Small-Cap ETF (benchmark)
6.21%
16.51%
XSLV: Invesco S&P Small Cap Low Volatility ETF
7.89%
12.99%
FNDA: Schwab Fundamental US Small Company Index ETF
7.43%
16.22%
VEA: Vanguard Developed Markets ETF (benchmark)
-1.60%
7.25%
GSIE: Goldman Sachs ActiveBeta International Equity ETF
0.37%
9.33%
FNDC: Schwab Fundamental International Small Company Index ETF
-1.61%
9.14%
VWO: Vanguard Emerging Markets ETF (benchmark)
-9.09%
6.27%
GEM: Goldman Sachs ActiveBeta Emerging Markets Equity ETF
-7.14%
9.09%
DGS: WisdomTree Emerging Markets Small Cap Dividend Fund ETF
-8.88%
7.94%
Fixed Income
TRAILING 3 MONTHS
TRAILING 12 MONTHS
BND: Vanguard Total Bond Market ETF (benchmark)
-0.18%
-0.56%
BND: Vanguard Total Bond Market ETF
-0.18%
-0.56%
VTIP: Vanguard Short-Term Inflation-Protected Securities ETF
0.48%
1.35%
BNDX: Vanguard Total International Bond ETF
0.35%
3.11%
EMB: iShares J.P. Morgan USD Emerging Markets Bond ETF
-4.19%
-2.75%
All data is rounded to the nearest hundredth of a percent. Data is trailing total returns provided by Morningstar, Inc. Past performance is not indicative of future results.