Market Review Q3 2018

October 17, 201810 Min Read
Quarterly Market Review

The Positive

The U.S. economy remains quite strong and has continued its expansion, most recently evidenced over the past three months by a brisk 3.6% estimated growth rate (https://www.frbatlanta.org/-/media/Documents/cqer/researchcq/gdpnow/RealGDPTrackingSlides.pdf) and a historically low 3.7% unemployment rate. (https://fred.stlouisfed.org/series/UNRATE/)

The Negative

The already massive U.S. federal deficit rose by 21% since last year, in the wake of the President and Congress passing vast tax cuts without accompanying spending decreases, further kicking the fiscal can down the road.

The Big Gambit

China’s $4 trillion investment in development projects across Asia and Africa could provide prosperity-inducing infrastructure, much like U.S. investments in Europe post-WWII, or lay the foundation for further U.S. economic isolation.

Since peaking in 2009, unemployment has steadily dropped each year, now settling at near-record lows
Sources: U.S. Bureau of Labor Statistics, U.S. Census Bureau. Contact United Income for more details.
But, wage growth has been modest, challenging expectations that scarce job openings drive raises
Sources: U.S. Bureau of Labor Statistics, U.S. Census Bureau. Contact United Income for more details.
Competition among companies is declining, as the largest firms gobble up more market share
Sources: U.S. Bureau of Labor Statistics, U.S. Census Bureau. Contact United Income for more details.
This increases their bargaining power, which may be one reason why paycheck increases are so low
Sources: U.S. Bureau of Labor Statistics, U.S. Census Bureau. Contact United Income for more details.

Dispatches from the Desk

China is the second largest economy in the world and Chinese companies have become significant global participants over the past decade – driving innovation, linking supply chains, and producing goods cost-effectively. Yet, this growth comes with caveats as China becomes more autocratic, ambitious, and aggressive. With China making headlines more frequently, we here at United Income often get questions surrounding the implication of China on building wealth. Specifically, should we include China in our United Income portfolio and what are the future expectations for their market?

Implications for your Portfolio

Over the past 15 years, stock prices in China grew by an average of 13.1% per year, while a global stock portfolio only grew by 8.7%. (Data from MSCI Inc. MSCI China Standard Index and MSCI ACWI Standard Index from Aug 31, 2003 to Aug 3, 2018 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.) The journey for an investor in China, however, has been a nail-biting roller-coaster ride: annual returns for the China stock portfolio ranged from a 51% decline to 83% growth. (Data from MSCI Inc. MSCI China Standard Index and MSCI ACWI Standard Index from Dec 31, 2003 to Dec 31, 2017 measured using the minimum and maximum annual returns (gross dividends) over that period. 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.) While extreme volatility in China’s market is unsettling, it’s why their stocks (and other emerging markets) have higher expected returns. Investors demand a premium to hold securities with larger variation and more uncertainty.

Underlying these soaring stock prices are rapidly innovating and growing Chinese companies. As this communist country has moved to more of a capitalistic economy, three companies stand out in particular – Alibaba, Tencent, and Xiaomi. Each created platforms that foster economic growth through entrepreneurship, which has successfully incubated countless new companies in China. And, investors have handsomely rewarded them: the combined market capitalization of these three young companies is $1.2 trillion, which is slightly less than Google and Facebook combined.

While extreme volatility in China’s market is unsettling, it’s why their stocks (and other emerging markets) have higher expected returns.

Alongside new companies that have flourished in China, the country’s population has flooded into the market. Our favorite statistic highlighting this transition: mobile payments in China reached $18.7 trillion last year, which is 100 times the amount in 2013 and more than the global transaction volume of Visa and Mastercard combined. (“As Regulators Circle, China’s Fintech Giants Put the Emphasis on Tech”, The Economist, Sep 13, 2018; https://www.economist.com/finance-and-economics/2018/09/13/as-regulators-circle-chinas-fintech-giants-put-the-emphasis-on-tech) It’s not unlike me when I discovered presents under our Christmas tree for the first time: Chinese consumers have similarly been given – most for the first time in their lives – new economic opportunities and are racing to seize and unpack them.

...mobile payments in China reached $18.7 trillion last year, which is 100 times the amount in 2013 and more than the global transaction volume of Visa and Mastercard combined.

Our Verdict

Stock investing in China comes with a certain amount of risk, as does all investing. Yet, this risk is rewarded over time for the patient investor. Your portfolio should benefit by investing in the explosive growth potential of China, and of emerging markets more broadly.

Implications for the Economy

It’s hard to talk about China and not mention their trade practices and foreign adventurism. Since joining the World Trade Organization in 2001, goods exports from the U.S. to China grew by 577% and goods imports from China to the U.S. grew by 394%. (https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china) The increase in global commerce between the U.S. and China has come with significant disputes and frustrations. For one, despite that astronomical growth in the U.S. economic opportunity in China, the country’s communist leaders have kept their economy mostly closed to foreign companies. They also have forced U.S. companies to share technology and partner with local firms. This has nurtured China’s economic growth and also driven growth for the U.S. But, it has come at the cost of Chinese firms being able to copy trade secrets and gain a competitive advantage against U.S. firms. China has also been accused of dumping, a trade tactic used to dominate market share, particularly with steel (Matthew Dalton and Lingling Wei, “How China Skirts America’s Antidumping Tariffs on Steel”, Wall Street Journal, Jun 4, 2018; https://www. wsj.com/articles/how-china-skirts-americas-antidumping-tariffs-on-steel-1528124339) and solar panels. (Keith Bradsher, “When Solar Panels Become Job Killers” The New York Times, Apr 8, 2017; https://www.nytimes.com/2017/04/08/business/china-trade-solar-panels.html) These trade practices are supported by state-owned enterprises which lack a profit motive and are solely focused on economic growth. It’s these kinds of practices that have led to the current disputes on trade that are so prominent in the news these days.

There are also misgivings about China’s massive $4 trillion foreign development program, the so-called Belt and Road Initiative. While the benevolent messaging from Beijing about this program has been focused on much-needed infrastructure investments in Asia and Africa that may spur economic development, more sinister intentions may belie these efforts. Some of these projects, for instance, increase foreign indebtedness to China, which will give China greater control over the global economy. Since Belt and Road projects also require the host nation to supply the majority of financing, that indebtedness may also become unsustainable as costs increase or during economic downturns. (“The Perils of China’s ‘Debt-Trap Diplomacy’”, The Economist, Sep 8, 2018; https://www.economist.com/asia/2018/09/06/the-perils-of-chinas-debt-trap-diplomacy) Together, these characteristics of China’s foreign giving have raised concerns among U.S. policymakers that the U.S. may face growing isolation in the global economy, much like communist countries faced in the years that followed World War II.

Our Verdict

There is plenty to be nervous about China regarding its growing competitive strength relative to the U.S. economy, which is heightened by the growing isolation of the U.S. from the global community. But, it is still too early to know whether China will actually follow through on its global commitments, U.S. firms (and others) are wisening-up about working in China, and America’s long-standing culture of innovation and entrepreneurship will be impossible for China to ever stifle.

Implications for our Investment Strategy

Since our job is to build you wealth, we look at all global opportunities, including those in China. At a high level, China is both a fascinating and frustrating country with appealing investment options and challenging market hurdles. On the one hand, our investors capitalize on China’s growth by our diversified investment strategies, which includes momentum-oriented investments and funds that are increasingly weighted to China securities as their market share grows. This allows us to capture the market return of that growth for our investors.

However, there are substantial risks to China’s hyper-aggressive global posture and growth, which we also manage for our investors with our dynamic rebalancing technology. The result is that when one asset class outperforms another, like China outperforming the U.S., your portfolio over time will very gradually reduce exposure to China, since it becomes progressively less likely that the growth will be maintained. Research indicates that our dynamic rebalancing strategy will build more wealth for you over time compared to both a simple buy-and-hold strategy and a periodic rebalancing strategy. (Walter Sun, et al., “Optimal Portfolio Rebalancing Strategy Using Dynamic Programming for Institutional Portfolios”, Massachusetts Institute of Technology, Dec 22, 2004; https:// papers.ssrn.com/sol3/papers.cfm?abstract_id=639284)

Our Verdict

Research indicates that investing in emerging markets like China have increased returns over time but carry higher levels of risk. Using our dynamic, tax-smart trading technologies can enhance returns by taking advantage of the growth opportunities, while balancing the risk that comes with that. Look in the future for an even more sophisticated approach that will take advantage of some of these same dynamics in the corporate debt markets.

If you would like to learn more about the benefits of dynamic rebalancing and how China may affect your investments, please contact your wealth manager today – or call 855-215-3032 (option 1).

Research indicates that our dynamic rebalancing strategy will build more wealth for you over time compared to both a simple buy-and-hold strategy and a periodic rebalancing strategy.

Member Results

At United Income, we are always focused on helping our members (We refer to clients of the United Income Wrap Program as our “members”. Performance information regarding our members in this letter does not include information from clients of our Traditional Portfolio Management Services.) 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 you, our member.

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

HIGHER INVESTMENT RETURNS

10 of the 18 ETFs that we use to build portfolios in member accounts have outperformed relevant ETF benchmarks over the trailing 12 months.

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LOWER TAXES

For members holding less than 50% of their accounts in stocks, 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 divided by ending account balances. 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 5.5 bps or 0.055%. For members holding more than 50% of their accounts in stocks, the average tax savings for the quarter was 6.9 bps, or 0.069%. We are currently forecasting this will add up to an average of $5,704 in extra wealth for each $100,000 invested in taxable accounts for the average member over their lifetime. (The average member is defined as 60 years old with life expectancy of 83 years old, based on Social Security’s Actual Life Table; https://www.ssa.gov/oact/STATS/table4c6.html) However, we are only currently measuring about 15 percent of our tax-savings strategies, so this wealth impact is likely much higher.

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LOWER FEES

On average, members that shared their previous advisor’s fee have saved $147 per month, or $1,764 per year, in advisory fees. We are currently forecasting this will add up to an average of $40,572 in extra wealth for the average member over their lifetime. (The average member is defined as 60 years old with life expectancy of 83 years old, based on Social Security’s Actual Life Table; https:// www.ssa.gov/oact/STATS/table4c6.html and account balances are estimated to remain flat.)

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On the Horizon

Over the next few months, United Income will be introducing personalized Medicare advice for each member. Similar to claiming Social Security, selecting the right Medicare plans can be a daunting task – the official Medicare guidebook is over 100 pages long! Determining your optimal Medicare plan requires a full summer reading list. To make this easier for you, United Income has digitized and personalized the majority of the Medicare rules and benefits, in conjunction with our Medicare Policy experts. We will notify you when this innovation is released so you can rest assured your Medicare plan is right for you.

Performance

As of September 30, 2018
Equity
TRAILING 3 MONTHS
TRAILING 12 MONTHS
VV: Vanguard Large-Cap ETF (benchmark)
7.55%
17.79%
SCHX: Schwab US Large-Cap ETF
7.53%
17.92%
USMV: iShares Edge MSCI Min Vol USA ETF
7.82%
15.48%
QUAL: iShares Edge MSCI USA Quality Factor ETF
8.75%
19.18%
VLUE: iShares Edge MSCI USA Value Factor ETF
6.97%
16.12%
MTUM: iShares Edge MSCI USA Momentum Factor ETF
8.81%
25.72%
VB: Vanguard Small-Cap ETF (benchmark)
4.76%
16.70%
XSLV: Invesco S&P Small Cap Low Volatility ETF
2.92%
9.96%
FNDA: Schwab Fundamental US Small Company Index ETF
2.48%
13.88%
VEA: Vanguard Developed Markets ETF (benchmark)
1.11%
2.74%
GSIE: Goldman Sachs ActiveBeta International Equity ETF
0.81%
4.65%
FNDC: Schwab Fundamental International Small Company Index ETF
-0.95%
1.47%
VWO: Vanguard Emerging Markets ETF (benchmark)
-1.74%
-3.10%
GEM: Goldman Sachs ActiveBeta Emerging Markets Equity ETF
-1.12%
0.35%
DGS: WisdomTree Emerging Markets Small Cap Dividend Fund ETF
-2.47%
-2.40%
Fixed Income
TRAILING 3 MONTHS
TRAILING 12 MONTHS
BND: Vanguard Total Bond Market ETF (benchmark)
0.03%
-1.27%
BND: Vanguard Total Bond Market ETF (also used in member accounts)
0.03%
-1.27%
FLRN: SPDR Bloomberg Barclays Investment Grade Floating Rate ETF
0.74%
2.27%
VGSH: Vanguard Short-Term Treasury ETF
0.15%
-0.10%
VGIT: Vanguard Intermediate-Term Treasury ETF
-0.34%
-2.06%
VCIT: Vanguard Intermediate-Term Corporate Bond ETF
0.94%
-1.56%
VTIP: Vanguard Short-Term Inflation-Protected Securities ETF
0.09%
1.01%
BNDX: Vanguard Total International Bond ETF
-0.20%
2.22%
EMB: iShares J.P. Morgan USD Emerging Markets Bond ETF
2.37%
-2.99%
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.