Element Wealth Blog

Attention 401(k) Retirement Plan Sponsors!

Join Element Wealth, Benefit Professionals, Inc. and Harper, Rains, Knight & Co. on Wednesday, October 24 to learn what you need to know about your retirement plan going into the end of the year. We will be looking at your responsibilities from an investment, audit and administration perspective.

Changes appear to be on the horizon for corporate retirement plans with a recent White House directive and proposals in Congress for multi-employer plans, tax credits to encourage small employers to set up workplace plans, and higher default contributions for popular auto-enrollment and escalation features, among others.

On the investment side, trade war concerns, rising interest rates in the U.S., and what appears to be a slowdown of 2017’s synchronized global growth story are all impacting global stock and bond markets. Firm partners of Element Wealth, Benefit Professionals, Inc. and HRK will provide the latest trends for plan sponsors and benefits providers.

You don’t want to miss this special event!

Where: Biaggi’s Ristorante Italiano – Renaissance at Colony Park – 970 Highland Colony Parkway – Ridgeland

When: Wednesday, October 24th

11:30 – 12:00 registration / check-in

12:00 – 1:00 Lunch & Learn

Click here to register.

Have questions? Feel free to email
juli-ann@myelementwealth.com
ava@myelementwealth.com

Element Wealth, LLC (EW) is an investment adviser registered with the Securities and Exchange Commission (SEC). EW only transacts business in states where it is registered, or where an exemption from registration is available. Registration as an investment adviser does not constitute an endorsement of the firm by the SEC, nor does it indicate a particular level of skill or ability. Past performance is not indicative of future results, and investors should realize that investing in securities involves risk of loss. Money invested in securities is not guaranteed against such loss by any governmental or non-governmental organization. EW is not a law or accounting firm, and does not give legal, accounting or tax advice.

 

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The Relationship Between Stocks and Bonds

In April’s article “What to Make of The Flattening Yield Curve,” we discussed the Federal Reserve’s current rate hike cycle and the impact it was having on the bond market. We then took annual 10-year Treasury Bond data as a proxy for longer-term bonds and evaluated what a “bear market” in bonds looked like. We concluded that a bear market in bonds is nothing like a bear market in stocks. This makes sense as bonds are a much less risky investment than stocks. Ultimately, a bear market in bonds is a short to intermediate period with flat to slightly negative returns.

The three periods we highlighted were 1955-1959, 1967-1969 and 1977-1980. In each of these periods, stocks, as represented by the S&P 500, produced positive returns, more than offsetting any declines in 10-year Treasury Bond returns. However, that does not mean that there were not years where both stocks and bonds produced negative results.

In the first quarter we saw both stocks and bonds post negative returns for the first time since October 2016. A recent Vanguard commentary decided to look further into the relationship between stocks and bonds. Using the MSCI USA Index as a proxy for U.S. stocks and the Bloomberg Barclays U.S. Aggregate Bond Index as a proxy for U.S. bonds, Vanguard evaluated the monthly data for the past thirty years plus the first quarter of 2018.

Over the 363 months, U.S. stocks lost value 126 times and U.S. bonds lost value 112 times. Naturally, the average decline in bonds was much less than stocks – 0.70% versus 3.34%. There were 47 occurrences when U.S. stocks and U.S. bonds declined in the same month and on 25 occasions they both posted negative returns over a three-month period. Fortunately, the median return for the 12 months following a decline in both U.S. stocks and U.S. bonds was 12.17% for stocks and 8.18% for bonds.

Why All the Talk About Bonds?

The brief equity market correction in the first quarter was primarily attributed to concerns about rising interest rates. In general, when interest rates go up stock valuations go down. But as Vanguard points out; that does not mean the next 12 months will necessarily be bad. In fact, both stock and bonds had positive median returns following months with simultaneous declines.

Today we are seeing rising interest rates affect certain parts of the market while others remain unscathed. Below is a table showing the year-to-date returns of some of the major U.S. ETFs.

 

 

 

Illustrated above by AGG, we find that bonds have produced negative returns for the year, while stocks, represented by IVV, have recovered from the first quarter and are now positive for the year. But if we break down the equity markets further, we find some discrepancies. High dividend paying stocks (HDV) are down 3.92% for the year and growth stocks (IVW) are outperforming value stocks (IVE) by 9.47% year-to-date. Ultimately, stocks in growth cycles remain nominally affected by the interest rate environment. May of these companies are technology companies. Technology is now almost 26% of the S&P 500. The average weighting of the technology sector is just below 16% going back to 1990.

Some investors are concerned about the re-emergence of technology within the overall equity markets. It has undoubtedly driven market valuations higher. But unlike the bubble produced in the late 90’s, this time technology companies are profitable. The greater conclusion to draw from this year’s performance is that rising interest rates are creating relative opportunities in dividend paying stocks and value stocks. In fact, per Ned Davis research we have seen the median price/earnings ratio of sectors in the S&P 500 drop from over 26 to under 20. This illustrates that the undercurrent of the market is a lot stronger than the waves on top of the water are showing. If economic trends continue to be positive and inflation remains in check, rising interest rates have repriced much of the stock market to more attractive levels.

As always, I welcome your feedback and questions.

Jeremy Nelson

[1] Vanguard: The link between stocks and bonds: Will history be our guide?

Advisory services offered through Sowell Management Services, a Registered Investment Advisor. The views expressed represent the opinion of Element Wealth. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Element Wealth’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.

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Don’t Miss The Culinary Issue of Portico!!

Element-Woodridge-Alliance

In the May/June 2018 issue, we will have the announcement of Element Wealth’s alliance with Woodridge Capital. Get your copy next week!!

 

Merger

 

Woodridge Capital, an SEC Registered Investment Advisor
Element Wealth Advisor Services, offered through Sowell Management Services, a Registered Investment Advisor.

 

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What to Make of the Flattening Yield Curve

The Rate Hike Cycle
The bond market has garnered a lot of attention in 2018. After a record run for the stock market, concerns about interest rates and potential inflation sent the market into correction territory in the first quarter. After finally embarking on a rate hike cycle in 2015, the Federal Reserve (Fed) is expected to ramp up the pace in 2018. We have already seen one rate increase and futures markets are now pricing in a 50% probability that we will see a total of four increases in 2018.

Effective Fed Funds Rate

Source: New York Federal Reserve

A Bear Market in Bonds?
Investors now fear a bear market in bonds due to rising interest rates. Over the past year the Bloomberg Barclays US Aggregate Bond Index is down 0.39%. But what does a bear market in bonds look like? Since 1976, there have been three negative calendar years for the index: 1994 (-2.92%), 1999 (-0.82%) and 2013 (-2.02%). It is important to understand that bond prices move inversely to interest rates, or in other words, as interest rates go up bond prices go down. Also, the longer the term of the bond, the more sensitive the price is to interest rate moves.

If we use an investment in the 10-year Treasury Bond as a proxy for longer-term bonds, we find 16 years with negative returns since 1927. The worst being 2009 when the return was -11.12%. However, in 2008 an investment in the 10-year Treasury returned 20.10% and in 2010 it returned 8.46%. Of those 16 instances, only three corresponded with negative returns for the S&P 500. In 1931 the 10-year treasury return was -2.56% while the S&P 500 declined 41.84%. In 1941 the return was -2.02% versus -12.77% for the S&P 500, and in 1969, -5.01% versus -8.24% for the S&P 500. Generally, in years where the 10-year Treasury return is negative we see very positive returns for stocks.

Below, we illustrate three periods with a cluster of negative returns or a “bear market” in bonds based on the 10-year Treasury.

Based on historic data, we find that a bear market in bonds is nothing like a bear market in stocks. Based on high quality bonds proxies such as the Bloomberg Barclays US Aggregate Bond Index and the 10-year Treasury Bond, we find that bear markets in bonds tend to be shallow and simply represent a short to intermediate period of slightly negative to below average returns. In the examples above, an investment in the 10-year Treasury Bond produced cumulative returns of -1.85% (1955-1959), -3.45% (1967-1969) and -3.10% (1977-1980). However, they were offset by positive returns in stocks, so a diversified portfolio faired alright through each of the periods. One explanation for this is that rising interest rates normally coincide with an improving economy, which over the long-term is good for stocks. Of course, at the end of the economic cycle we may see inflation and thus the Federal Reserve raising interest rates in response. This can lead to a slow down in the economy and a correction or bear market in stocks.

The Flattening Yield Curve
With the Federal Reserve fully committed to its current rate hike cycle, we have seen a significant flattening in the yield curve. In this case it is because the short-end of the yield curve is rising at a faster rate than the long-end of the curve. Over the past year, the 2-year Treasury yield has increased by 1.25% while the 10-year and 30-year have increase by 0.71% and 0.24%, respectively.

Treasury Yield Curve

Source: US Treasury

The flattening of the yield curve has some investors concerned because, at extremes, when the yield curve inverts and short-term rates are higher than long-term rates, history suggests that a recession is just around the corner. We still have some time to go but with two to three more rate hikes from the Fed this year, further flattening is likely.
With inflation in check, at or below the Fed’s target of 2%, and economic growth accelerating, we must ask why the Fed is so intent on raising rates and why long-term rates are not moving up as fast as short-term rates.

First, the Fed’s response to the Financial Crisis was the most aggressive monetary stimulus in the history of our country. With the economy on solid footing it is important for the Fed to normalize its policy. Even after six rate hikes, the monetary environment is still very accommodative and easy money has spurred on significant risk taking in markets and the economy. Too much risk-taking leads to bubbles and when bubbles pop significant damage is done to the economy. Many would say we are already in a bubble but only time will tell whether that is true. There is no doubt that stock valuations are above historic norms and certain real estate markets have become elevated. The Fed believes it is necessary to continue to increase rates to offset any inflationary pressures that may come about from the current government fiscal stimulus and to keep markets from overheating.

This explains why the short-end of the yield curve is rising but the long-end is holding relatively steady. We believe this is for two reasons. First, US government bonds yield significantly more than other government bonds. The 10-year Treasury yields approximately 2.3% more than the 10-year German government bond and 1.4% more than the UK 10-year government bond. This higher yield attracts foreign monies looking for better yields. But primarily, it reflects the market’s long-term inflation expectations. Last week, the Congressional Budget Office (CBO) lowered its non-accelerating inflation rate of unemployment (NAIRU) estimate from 4.7% to 4.6%. NAIRU represents the level of unemployment at which it does not cause inflation. When the unemployment rate gets too low, wages push higher and with more money in their pockets consumers demand more goods, thus pushing prices higher. The Fed’s NAIRU estimate is 4.5%. Research from Ned Davis Research suggests that the key unemployment level to look for is 0.8% below the Fed’s NAIRU estimate. That would be 3.7%. With the unemployment rate at 4.1% it appears we have a little further to go before inflation becomes an issue.

Conclusions
We fully expect interest rates to rise over the remainder of 2018 and for bond returns to be lower than historical averages in the coming years. It is important for investors to understand that just because the word “bear” is in a bond bear market, it does not mean that large losses are imminent. Bonds pay interest and return principal at maturity. Therefore, high quality bonds do not expose investors to the same risks as stocks and bear markets in bonds are mild compared to bear markets in stocks. We believe that reducing long and intermediate-term bond exposure and adding short-term high yield bonds is a good way to reduce interest rate exposure while maintaining yield in bond portfolios.

As always, we welcome your feedback and questions.

Jeremy Nelson

Advisory services offered through Sowell Management Services, a Registered Investment Advisor. The views expressed represent the opinion of Element Wealth. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Element Wealth’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.

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When Two Great Things Come Together

Element Wealth is excited to announce its alliance with Woodridge Capital! Element and the team at Woodridge have been working together over the past few months to build a truly unique wealth management experience for clients. Woodridge Capital opened its doors in 2006 and is currently run by its two partners, Barry Smith and Danny Williams. The team at Woodridge Capital bring decades of experience and an expertise in dynamic asset management to the table.

With an anticipated final merger date in Q2 2018, the new firm will operate under the name Element Wealth. It will utilize Woodridge Capital’s existing Registered Investment Advisor and integrate the technology platform built out by Element.

The firm will focus on bringing comprehensive financial solutions to its clientele. The firm will build custom portfolios for clients that are designed to fit their unique risk tolerances and preferences while meeting upside expectations.

“When I launched Element Wealth in the summer of 2017, I could not have imagined what would have unfolded in such a short period of time. Barry and Danny have been amazing to work with and the response from our clients about the partnership has been incredible. We have shared ideas and challenged each other as we have thought everything out. Ultimately, I firmly believe we have built something better than we could have on our own efforts alone.” – Jeremy Nelson, Founder of Element Wealth

“I am ecstatic about what Jeremy and Element Wealth bring to our firm. His background in asset management, financial planning, and retirement plans will certainly benefit our clients. Our combined research efforts and expertise in asset management has set us up to better serve all our clients going forward.” – Barry Smith, Partner at Woodridge Capital

“I’d known Jeremy for over a decade, specifically from our times on the board of the MS Financial Planning Association. When I heard he had launched Element, I immediately reached out and set up a meeting. The new technology platform and enhanced services are going to help us take our firm to the next level.” – Danny Williams, CFP, Partner at Woodridge Capital

 

Woodridge Capital, an SEC Registered Investment Advisor

Element Wealth Advisor Services, offered through Sowell Management Services, a Registered Investment Advisor.

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Don’t miss our 2018 Economic and Market Forecast in Meridian! Seating is limited!

Investments
Element Wealth & Woodridge Capital Economic and Market Forecast

Not sure where to go next with your investments? Element Wealth and Woodridge Capital are coming to Meridian for our 2018 Economic and Market Forecast. Co-hosted by Lee Yancey, Danny Williams, and Barry Smith, the event will feature Element Wealth founder Jeremy Nelson analyzing hot-button issues facing our economy, along with market expectations.

The luncheon event will be held Tuesday, March 20th from 11:30 to 1:00 at Weidmann’s.

Click the link below to register:

Meridian Economic & Market Forecast

 

 

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