4th Quarter Investment Commentary

Contributed by: Angela Palacios, CFP®, AIF®

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2017 in Review and Outlook for 2018

Fidget spinners, bitcoins, and Trump.  If you have young children, you could not miss the fidget spinner craze that hit in April of this year.  This simple toy rotates on a ball bearing.  By the time I got around to getting my 10-year-old child one in mid-May for her birthday, they were SO yesterday.  My major parenting fail of 2017!  In the financial world, another mania took over.  Bitcoin, while not brand new, certainly gained a ton of traction this year as an alternative cryptocurrency.  The price of Bitcoin surged from below $1,000 per bitcoin to more than $19,000!  This paved the way for many other cryptocurrencies (Bitcoin competitors) making their way to center stage with astonishing returns also.  If you want more information, check out this blog Talking Bitcoin, written by Nick Boguth earlier this year. 

The news cycle has also revolved around President Trump this year.  While failing to overhaul Obamacare or U.S. trade policy, he was successful in getting some long-anticipated tax reform through to round out his first full year as our President.

The past year turned out to be far more bullish than many expected.  International and emerging markets outpaced U.S. markets.  Growth investing beat value investing, while Bonds returned little more than their yield.  2018 has a tough act to follow!

Tax Reform and its Impact on the Economy

Although the tax cut seems to favor corporations, much of the net tax cuts are going to the individual.  The tax act should increase after-tax income for most American households both directly, through lower personal taxes, and indirectly, through the impact of higher dividends and stock prices resulting from the cut in corporate taxation.  As people spend more, GDP should increase and unemployment should continue to decrease possibly causing the wage inflation we have been waiting for.  This chart shows the level of unemployment (gray line) and the level of wage inflation the (blue line). The dotted lines for each color are average levels.  You can see that both are below their average levels.  Usually when unemployment is below average the wage growth line rises back to its long-term average level, but this has not happened yet.  Retiring higher-paid baby boomers are being replaced with lower-paid millennials entering the workforce and this has had a significant downward pressure on wages keeping it well below its long-term average growth rate. 

If wages finally start to increase, this could cause inflation to pick up somewhat. This would be a positive influence on the stock market in the short run.

Tax Reform and its Impact on Equities

Looking at the influence tax reform will have on corporations, smaller companies will likely see a more impactful tax benefit with the corporate tax rate cut to 21% (which consequently is just below the average of the countries in the OECD or the organization for economic co-operation and development).  Currently, small cap companies pay the highest tax rates.

After a strong year for equities, the impact of tax reform could be more muted than you might think as the markets already anticipated some corporate tax reform passing. Quite often, equity prices factor these events in long before the pen hits the paper.

Tax Reform and its Impact on Fixed Income

Bond markets will have mixed implications from tax reform.  Companies that over-levered and don’t have strong positive cash flow will be penalized.  This new law places limits on the interest that corporations can deduct.  This will likely affect companies who are issuers of high yield debt negatively.  While companies investing for growth by making capital expenditures will be rewarded as, they are now allowed to expense a larger amount of these capital expenditures.

Municipal bonds should fare well next year with limits being placed on state tax and property tax deductions, especially in states with higher tax rates.  Other opposing forces could affect supply within the municipal bond market in the coming year from tax reform.  The law eliminates the issuance of advance refunding bonds that are used to retire old debt.  These bonds help boost supply by 10-20% each year in the municipal bond market.  On the flip side, corporations will be less incentivized to hold onto municipal debt as their tax rates have been slashed. If they sell these bonds into the market place that could increase supply, which could lower bond prices.  However, these two forces may cancel each other out.  It looks like the elimination of advance refunding bonds will likely offset any boost in supply from corporations selling.

Interest rates on the rise

The Fed raised short-term interest rates again in December, which was highly anticipated.  They are planning to continue with three more rate hikes in 2018. The bond market already anticipates these rate hikes, which means they should be priced in.  Jerome Powell is set to take over for Janet Yellen in February as the new Federal Reserve Chairperson.  It is unlikely he will change the trajectory of increases expected in 2018. 

The rate hikes have resulted in a flattening of the yield curve this year.  The charts show side-by-side where the yield curve started 2017 and where it is finishing 2017.  If you recall, an inversion of the yield curve, downward instead of upward sloping from left to right, or short-term rates higher than long-term rates, usually signals an oncoming recession.  While we aren’t there yet, this can happen quickly, so it is something we are keeping a close eye on.

Source: http://stockcharts.com/freecharts/yieldcurve.php

Low volatility

The exciting part of 2017 was the lack of excitement.  2017 saw incredibly low average daily moves in the S&P500.  You can see from the below chart that standard deviation, or the variation of price movement by percent, for the S&P 500 is well below the typical range.  It is currently below 6%, which has only occurred five times since 1940.  Typically, it is between 10% and 18% each year.

Source: https://www.mutualfundobserver.com/2017/09/historically-low-volatility/

During times like this, it is easy to get lulled into a false sense of security causing you to potentially reach for a little more risk to spice up your returns.  But, it is important to remember that your risk tolerance isn’t nearly as stable as you think it is.  Outside of our natural behavioral tendencies to want to chase great returns or hide from stocks after a sharp drawdown, our natural progression through life’s milestones can influence our tolerance for risk.  Milestones like a house sale, job change, or death of a loved one can influence our desire to take on risk just like the market performance and volatility.  This makes it hard to compare yourself and your portfolio’s returns to a static benchmark over the years.  Before making any drastic changes to your investment strategy, it is important to discuss with your financial planner the importance of a diversified portfolio that fits with your unique long-term goals and tolerance for risk. 

As we welcome the New Year, we don’t want to miss the opportunity to express our gratitude of the trust you place in us each and every day.  Thank you!

On behalf of everyone here at The Center,

Angela Palacios, CFP®, AIF®
Director of Investments
Financial Advisor

Angela Palacios, CFP®, AIF® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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Check out our other Tax Reform articles:

Changes to Federal Income Tax Brackets

Changes to Standard Deduction, Personal Exemption, Misc. Deductions, and the Child Credit

Changes to State and Local Tax Deduction

Changes to Mortgage Interest Deduction (including Home Equity Loans and LOC Implications)

Changes to Estate Tax Planning in 2018 and Beyond

Changes to Charitable Giving and Deductions

Changes to Medical Deductions

Changes to Business & Corporate Tax, and Pass-Through Entities

The information contained in this commentary does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the professionals at The Center and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. This material is being provided for information purposes only. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Investments mentioned may not be suitable for all investors. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Prior to making an investment decision, please consult with your financial advisor about your individual situation. The prominent underlying risk of using bitcoin as a medium of exchange is that it is not authorized or regulated by any central bank. Bitcoin issuers are not registered with the SEC, and the bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment, and a potential total loss of their investment. Securities that have been classified as Bitcoin-related cannot be purchased or deposited in Raymond James client accounts.

 

Investment Commentary: 3Q 2017

Contributed by: Angela Palacios, CFP®, AIF®

This summer came and went with no shortage of topics for investors to worry about.  Low inflation, natural disasters, and geopolitical tension kept the headlines busy.  Despite all of this, the quarter ended on a positive note.  The uptick in markets was spurred on by a wide-spread pick up in global growth.  Recession risks continue to remain muted as dovish global central banks continue to inject liquidity in the system, or only very slowly begin to pull back on the injections.  In general, economic data remains strong.   We remain watchful for a slowing, particularly in manufacturing, business and consumer confidence, as these are early indicators of the tide of the economy turning. However, they are still positive.

Diversification is coming back into style as international and emerging markets continue to perform stronger than their domestic counterparts this year.  The S&P 500 Index ended the quarter returning 14.24% through the 30th of September.  International markets are truly the bright spot with the MSCI EAFE returning 19.96% and the MSCI EM Index returning 27.78%.  Bonds ended the third quarter with a respectful 3.14% return coming from the Barclays US Aggregate Bond Index.

Rates remain unchanged

In September, the Federal Reserve (Fed) kept rates unchanged, but also announced additional information on how it will begin to unwind the $4.5 trillion balance sheet in October. 

The Committee intends to gradually reduce the Federal Reserve's holdings of treasury securities and agency securities--agency debt and agency mortgage-backed securities (MBS)--by decreasing the reinvestment of the principal payments it receives from securities holdings. Each month, such payments will be reinvested only to the extent that they exceed a pre-specified cap. The caps will rise gradually at three-month intervals over a 12-month period and the maximum value of the caps at the end of the 12-month period will be maintained until the size of the balance sheet is normalized. (https://www.federalreserve.gov/monetarypolicy/policy-normalization-qa.htm)

This plan to shrink the balance sheet seems to reflect the Fed’s positive view of the U.S. economy.

Proposed tax changes being debated

Political stakes are high for President Trump to score a legislative win on what remains of his campaign promises.  In late September, he unveiled a proposal to slash taxes for individuals and businesses.  To simplify the tax code, Republicans have proposed condensing from seven tax brackets down to three (12%, 25% and 35%), doubling the standard deduction to help tax payers eliminate the need to itemize, and “significantly increasing” the child tax credit while also adding a new tax credit for the care of non-child dependents (elder-care situations).

Currently, many taxpayers use itemized deductions, claiming write-offs for things like charitable contributions, interest paid on a mortgage, state and local taxes. If the standard deduction becomes larger, fewer taxpayers will need to itemize, reducing the incentive to hold a mortgage or contribute to charity.

President Trump is also proposing to cut the corporate tax rate from 35% down to 20%.  A new tax rate would be established for pass-through entities which represent about 95% of businesses in the United States.  Generally when corporate tax rates are cut, markets perform very well in the year following the tax cut. The chart below demonstrates that after the rate cut for corporate taxes (Orange area below the line), the following 1 year returns on the S&P500 are quite positive (blue bar above the line).

Michigan 529 plan changes

In September, the Michigan 529 Advisor Plan, transitioned its program from Allianz Global Investors to Nuveen Securities, LLC.  Account numbers stayed the same and investments mapped over to similar strategies; if you had one of these accounts, the transition was seamless.  Some of the benefits of the change include an expanded investment line-up, more leading edge investment managers and lower fees.  If you have any questions don’t hesitate to reach out!

After several years of equity volatility near historic lows, this quarter we again experienced the speed and scale at which geopolitics can possibly move markets. We remain committed to the view that managing volatility is at the heart of proper portfolio design.  It is a responsibility we take very seriously and we thank you for the continued trust you place in us to help you with these decisions!

On behalf of everyone here at The Center,

Angela Palacios, CFP®, AIF®
Director of Investments
Financial Advisor

Investment Pulse: Check out Investment Pulse, by Nick Boguth, a summary of investment-focused meetings for the quarter.

Investor Ph.D Series: How Currency Movement Effect International Investments

Investor Basics Series: Nick Boguth, Investment Research Associate, talks about exchange rates.

Of Financial Note:  Jaclyn Jackson, Portfolio Coordinator, shares a look at the asset flow for 3rd quarter.

Angela Palacios, CFP®, AIF® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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This information does not purport to be a complete description of the securities, markets, or developments referred to in this material; it has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of Angela Palacios and are not necessarily those of Raymond James. This information is not a complete summary or statement of all available data necessary for making and investment decision and does not constitute a recommendation. Investing involves risk; investors may incur a profit or loss regardless of the strategy or strategies employed. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in emerging markets can be riskier than investing in well-established foreign markets. Asset allocation and diversification do not ensure a profit or guarantee against loss. Past performance is not a guarantee of future results. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Barclays Capital US Aggregate Index is an unmanaged market value weighted performance benchmark for investment-grade fixed rate debt issues, including government, corporate, asset backed, mortgage backed securities with a maturity of at least 1 year. Please note direct investment in any index is not possible. Index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.

Investor Ph.D: How Currency Movement Effect International Investments

Contributed by: Angela Palacios, CFP®, AIF®

Investors with the patience to hold on to their diversified portfolio that maintains a component of international have likely been rewarded this year.  Before this year, investors challenged the advice of diversifying their portfolio away from the U.S. as international investments, represented by the MSCI EAFE, noticeably lagged U.S. returns in recent years.  The chart below shows how the MSCI EAFE has performed vs. the S&P 500.  When the gray shaded area is above 0, this represents a time when the prior three years of returns have been dominated by the MSCI EAFE outperforming the S&P 500.  When you drill down into specific extended time periods when this happens, you can see that much of the returns come from the impact of the currency return (the lighter green portion of the return).  You see in recent years the S&P 500 has significantly outperformed international investments. 

A weakness in the U.S. dollar has contributed to the outperformance year-to-date by the MSCI EAFE (as of 9/30/2017 the MSCI EAFE was up XX% vs. the S&P 500 was up XX%).  When the dollar is in a cycle of weakening against foreign currencies, there is a natural tailwind helping performance.  Coupled with the global economy strengthening and political risks receding due to a failed populist movement in Europe, this could be a continuing recipe for international investing tailwinds.

Take a look at the impact on stock markets around the globe during these periods of different U.S. dollar trends:

Source: http://awealthofcommonsense.com/2017/04/how-the-dollar-affects-the-stock-market/

When the U.S. dollar index is retreating, Foreign and Emerging markets have outperformed and vice versa.  If the U.S. dollar continues its current trend of weakening or even levels out, we could continue to see the performance story dominated by foreign investments.

Angela Palacios, CFP®, AIF® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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This information has been obtained from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Opinions expressed are those of Angela Palacios and are not necessarily those of Raymond James. There is no assurance the trends mentioned will continue or the forecasts provided will prove to be correct. Investing involves risk, investors may incur a profit or loss regardless of the strategy or strategies employed. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in emerging markets can be riskier than investing in well-established foreign markets. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks. Please note direct investment in an index is not possible. Index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results.

Investor Basics: Exchange Rates

Contributed by: Nicholas Boguth

An exchange rate is just the price of one currency in terms of a different currency. For example, as I wrote this blog on 9/29/17, the USD/EUR exchange rate was .85. This means that 1 US Dollar would buy 0.85 Euro.

Exchange rates fluctuate though, and this is where things get complicated for investors. Inflation, interest rates, asset flows, trade, and economic stability are all factors that move exchange rates. Below is a chart showing just how much the exchange rate between the US Dollar and the Euro has fluctuated in the past 10 years.

Now these exchange rates may not directly affect you in your day to day purchases, but if you are invested internationally, exchange rates affect your portfolio. Head on over to our Director of Investments Angela Palacios’s blog (coming on Thursday!) to read about exactly how exchange rates have affected returns recently.

Nicholas Boguth is an Investment Research Associate at Center for Financial Planning, Inc.® and an Investment Representative with Raymond James Financial Services.

Financial Note: Asset Flow Watch 2017 3Q

Contributed by: Jaclyn Jackson

One of the most common ways to monitor consumer confidence and investor sentiment is to watch fund inflows and outflows.  Market analysts use fund flows to measure sentiment within asset classes, sectors, or markets. This information (combined with other economic indicators) help identify trends and determine investment opportunities.

July trends picked up where June left off, as international equities and taxable bonds continued to receive inflows. 

Most of these flows came through passive funds, but active flows were still positive.  Conversely, US equities saw outflows as valuations appear to be fair or high (depending on whom you ask) and administration confidence declines.  Accordingly, The International Monetary Fund decreased their US GDP growth forecast from 2.3% to 2.1%.  In terms of internationals, investors are opting for developed markets through foreign large blend funds.  Ultimately, this is a play for Europe.  The International Monetary Fund increased its expected growth rate from 1.7% to 1.9% in Europe.   Investors also sought out emerging market funds as the MSCI Emerging Markets index has double-digit returns year to date (28.3% returns YTD at the end of August).

In August, international equity inflows were positive but less positive than in July. 

The slowdown reflects lackluster corporate earnings internationally and uncertainty about North Korea.  Nonetheless, internationals remain compelling to investors with rebounds from Japan and Europe progressing.  MSCI EAFE returns have remained ahead of the S&P 500 in 2017.  Taxable bonds, specifically intermediate-term bond funds, remained the leading category group for inflows. Intermediate bond funds hit the “sweet spot” for many investors because they are usually not as severely impacted by rising rates as long term bonds and typically generate more return than short term bonds.  From January 1st through August 15th, intermediate bonds gained 3.2% beating both the Bloomberg Barclays US Bond Index and 2016 returns.  Differing from June and July, investors are trending back towards active management for their bond funds.

As of writing this, October 4th, 2017, September flows mimic July and August with outflows from US equities and continued inflows to international equities and taxable bonds. 

There are also positive inflows for municipal bonds and alternatives.  Outflows from the US are mostly from growth (especially large growth) and US large blend funds.  International equities experienced outflows last week, but are net positive for the month.  Bond inflows are steady with investors largely continuing to invest in intermediate term bond funds as wells as modestly investing in high yield municipals funds and national intermediate municipal bonds.

Bonds Lead the Pack

Even as rates rise, investors continue to pour assets into bond funds. Why is that the case? Income and diversification seem to motivate the trend.  Even if interest rates rise and bond prices go down, investors still want the guaranteed income stream bonds provide.  Some may also feel they can pick up higher payouts from new bond issues as interest rates increase.  In terms of diversifications, investors have seen gains from their US equities and feel like it is time to rebalance into a true stock diversifier; bonds.

Jaclyn Jackson is a Portfolio Administrator and Financial Associate at Center for Financial Planning, Inc.®

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This information does not purport to be a complete description of the securities, markets, or developments referred to in this material; it has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of Jaclyn Jackson and are not necessarily those of Raymond James. This information is not a complete summary or statement of all available data necessary for making and investment decision and does not constitute a recommendation. Investing involves risk, investors may incur a profit or loss regardless of the strategy or strategies employed. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in emerging markets can be riskier than investing in well-established foreign markets. Asset allocation and diversification do not ensure a profit or guarantee against loss. Past performance is not a guarantee of future results. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Barclays Capital US Aggregate Index is an unmanaged market value weighted performance benchmark for investment-grade fixed rate debt issues, including government, corporate, asset backed, mortgage backed securities with a maturity of at least 1 year. Please note direct investment in any index is not possible.

Investment Pulse: 3Q 2017

Contributed by: Nicholas Boguth

We’ve been busy here in the Investment Department! Check out some of our research highlights from the third quarter.

Angela Palacios, Director of Investments at The Center, attends Capital Group Advisor Forum

Angela traveled to Capital Group’s headquarters in California, to look under the hood at their investment strategies focusing on their process, people and investment outlooks.  You may know the strategies as the American Funds family. The discussion spanned from macro-economics to fixed income and equity discussions. On the macroeconomic front they discussed their recession outlook. Anne Vandenabeele, Economist, stated that expansions don’t die of old age, they die because imbalances build up in the economy or the Federal Reserve raises rates too quickly. They don’t see either of these scenarios right now. Most severe bear markets are when you have a bear market combined with a recession. While there may be a bear market in the next several years they don’t see a recession occurring at the same time. 

Clayton Shiver, Portfolio Manager at Stadion Money Management

Part of our investment process is to stay on top of investment products being offered in the marketplace. Nick Boguth met with Clayton Shiver to discuss Stadion’s alternative product platform and understand the team’s investment process. Clayton discussed their three sleeve alternative approach that included an equity, income, and trend sleeve implemented with the buying and selling of stocks and options in order to generate very different potential returns from the S&P 500 or Barclays US Aggregate Bond Index.

Matt Lamphier, Portfolio Manager at First Eagle

Matt Lamphier, director of research for the Global Value team at First Eagle Investment Management, joined us at our office for a jam-packed hour of investment updates. We discussed First Eagle’s investment process, outlook, and rationale behind their investments. Matt stressed the importance of being a value investor, and choosing companies that will outperform over the long term. One surprising statistic that Matt shared was that the average timespan of a stock in their portfolio is over 10 years!

What to expect next time…

We have a busy schedule next quarter and are looking forward to sharing highlights from our upcoming conferences including: Thornburg Investment Management, First Eagle, and Investment News.

Nicholas Boguth is an Investment Research Associate at Center for Financial Planning, Inc.® and an Investment Representative with Raymond James Financial Services.

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Nick Boguth and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Raymond James is not affiliated with Anne Vandenabeele, Clayton Shiver, Stadion Money Management, Matt Lampier and/or First Eagle Investment Management.

ESG Investing: The Little Engine That Could

Contributed by: Jaclyn Jackson

As children, many of us were made familiar with The Little Engine That Could, a story about a small railroad engine that overcame the seemingly impossible challenge of pulling heavy freight cars up and over an intimidating mountain. As we witness the unraveling of many government policies, alliances, and programs helpful to ESG (Environmental, Social, Governance) investing such as dismantling carbon dioxide mitigation, leaving the Paris Agreement global pact, looming EPA budget cuts, etc., it would appear that an insurmountable amount of challenges could hurt ESG investment product performance.

Yet, like The Little Engine, the trend towards ESG investing is plugging ahead with great intensity. In fact, the recent focus on these issues has fired up investors and fund companies.  Leading research firm, Morningstar, has seen a four-fold increase in the use of ESG data in its cloud-based research platform used by asset managers, advisory firms and independent wealth managers since Trump’s election.  Net flows into ESG products in the first 6 months of 2017 have been greater than both 2014 and 2015.  With a dozen new open-end sustainable mutual funds, 2017 flows are also positioned to beat 2016 numbers.

Performance

Excluding ethical motivations, ESG transparency helps investors get a unique, “under the hood” analysis of company risk (or stability) that complements traditional research methods. For example, ESG risks are sometimes more prominent in foreign markets (autocratic governments, human rights issues, wage disparities, etc.).  The graph below demonstrates that ignoring ESG factors may lead to reduced returns for investors in emerging markets.

A study done by European Centre for Corporate Engagement (ECCE) also supports correlation between good ESG practices and financial performance for emerging-market companies.  Even in the case of developed markets, Hermes' global equities team research found that avoiding companies with bottom-decile corporate governance rankings could increase returns by 30 basis points (bps) per month.  To boot, research by index provider, MSCI, indicated that a company’s efforts towards sustainability, such as fair labor practices, good environmental stewardship, and diverse internal leadership, improves returns.

Is it Just Smart Business?

Going back to our metaphor, imagine that the Little Engine was little by design.  While the Little Engine had fewer cylinders and less horse power, it also burned less fuel.  Since the Little Engine was smaller, it weighed less and minimized wear and tear on the parts that supported it. Perhaps the company that owned or built the Little Engine designed it to save money on fuel, have fewer repairs, and prevent EPA emission fines from cutting into profits. 

This begs the question, Are companies that manage environmental, social, and governance factors just practicing smart business strategy?  Phil Davidson, co-manager of American Century Equity Income, stated it best in a Barron’s article, “Cutting corners on environmental issues, for instance, can lead to lawsuits, fines, and damages. Businesses that use less water and less power have lower costs and operate more efficiently. Good corporate governance plays a winning hand in capital allocation and is critical to corporate longevity. If a company is being managed for the short term to maximize revenue, that’s not sustainable.” 

Here to Stay

Despite political noise, it seems some fund companies and investors alike continue to embrace ESG strategies.  Research indicates monitoring risks factors that may affect the sustainability of a company may prove to support higher potential returns.  Perhaps ESG strategies are finally “up the hill” as they seem to be a more common part of one’s investment strategy.

Jaclyn Jackson is a Portfolio Administrator and Financial Associate at Center for Financial Planning, Inc.®

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The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Jaclyn Jackson and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing involves risk and investors may incur a profit or a loss. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.

2nd Quarter Investment Commentary

Contributed by: Angela Palacios, CFP®, AIF®

You may have noticed 2017 has been an easy year to open your statements. Markets around the world have been trending in a positive direction with only short-lived bouts of risk aversion. As a whole, volatility is extremely low and getting lower by the day it seems. U.S. markets have enjoyed positive returns of 10% for the S&P 500 so far this year as of June 30, 2017. The Barclays US Aggregate Bond Index has also been up 2.27%.  Overseas has been the big story of the year with the MSCI EAFE returning 14.1% and the MSCI Emerging Markets Index returning about the same. This strong increase has occurred despite headwinds from Brexit negotiations that are beginning and are expected to be challenging as well as concerns over high and quickly growing debt levels in China.

The Federal Reserve has approved one more rate hike this quarter, during June, which was fully anticipated by markets. One more has been telegraphed by the Fed for this year and would likely come late fall/winter if it does at all. This last potential rate hike of 2017 will depend on the strength of economic data over the coming months.

The Economy

Our domestic economy continues to grow slowly but steadily. Wages are growing, although, at a pace slower than historical averages. Inflation has been more subdued than expected, in large part because wage growth has been muted. Unemployment has continued to fall, and it has become harder to fill open job positions. Low unemployment ultimately should result in wages increasing, but, so far, we have not seen an impact here in a meaningful way.  Energy prices increased over a year ago, and rent and housing costs are on the rise. These last two points serve to take away some of our discretionary spending money which is important to bolster Gross Domestic Product growth that has come in below the Fed’s expectations of 2.2% so far this year. 

Brexit – One year later

A little over one year ago, the British voted to exit the European Union on June 23rd, 2016.  As you may recall, this created quite a bit of volatility in the market leading up to and immediately after the decision. The British government stepped in quickly, vowing to support liquidity at banks and emphasized it would be an orderly divorce. This action assuaged fears resulting in the markets here in the U.S. as well as overseas bouncing back to where they had been prior the decision.  So one year later, what has the impact been?

1. The British pound is about 15% cheaper than where it was last year. While a cheaper pound helps boost the country’s exports, it, unfortunately, serves to increase the price of imports causing inflation within the country. If you were ever going to take a trip to England, now may be a good time as our dollar is much stronger than it has been in recent years!

2. Business investment in the U.K. has softened dramatically due to the uncertainty surrounding potential future tariffs. The Gross Domestic Product growth has also slowed as a result.

3. Immigration is falling into the U.K. meaning many jobs are having a hard time finding workers for farming and construction positions.

Affordable Care Act—Repeal?

ObamaCare is facing a threat of repeal in the Senate. The Senate majority leader, Mitch McConnell, is working to revise the bill to be looked at again in July after it met resistance from some members of the Republican Party. If he can’t create a bill all Republicans can agree on, then they will be forced to seek a more bi-partisan supported bill, further delaying any change. If repealed, volatility would likely increase in the healthcare sector, but the market effects would be very dependent on the terms that pass. This is something we will continue to keep our eyes on.

While it has been a tranquil year thus far, it is important not to let the resilience in stock markets lull you into a false sense of security. It is easy to forget what downside volatility feels like when we haven’t experienced a meaningful pullback in so long. Rebalancing your portfolio and keeping risk in check is important particularly in this stage of a bull market, when it may be tempting to reach for more. Check out our recent Mid-Year Investment Update webinar if you want to hear more information on these topics as well as other headlines this quarter!

On behalf of everyone here at The Center,

Angela Palacios, CFP®, AIF®

Director of Investments
Financial Advisor  

Investment Pulse: Check out Investment Pulse, by Angela Palacios, CFP®, a summary of investment-focused meetings for the quarter.

Investor Ph.D Series: Why paying a premium for bonds may be ok.

Investor Basics Series: Nick Boguth, Investment Research Associate, introduces us to bond options.

Of Financial Note:  Jaclyn Jackson, Portfolio Coordinator, continues her series on behavioral investing here.

Angela Palacios, CFP®, AIF® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Angela Palacios and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations. The MSCI Emerging Markets Index is designed to measure equity market performance in 25 emerging market indexes. The index’s three largest industries are materials, energy, and banks. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Rebalancing a non-retirement account could be a taxable event that may increase your tax liability. Please note that international investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in emerging markets can be riskier than investing in well-established foreign markets.

Source: http://www.independent.co.uk/news/business/news/brexit-latest-news-business-economic-costs-banks-one-year-vote-anniversary-eu-exit-a7802596.html

Investor Ph.D.: Paying a Premium

Co-Contributed by: Angela Palacios, CFP® and DewRina Lee

We aren’t talking Healthcare or Prada even, though you pay premiums for both. Rather, we are discussing why investors may pay a premium for bonds. Bonds are frequently purchased at prices below or above par; that is, at a discount or a premium. Bonds trade at a discount when the coupon rate is lower than the market interest rate, and they trade at a premium when its coupon rate is higher than the market interest rate.

For the purpose of this blog, we will be focusing mainly on the reasons behind why someone may choose a premium bond.

Take the following scenario:

Intuition seems to indicate that when deciding between a discount bond at a price of $970 and a premium bond at a price of $1,030, an investor should take the discount option. It’s always more fun to buy that Prada purse when it’s on sale right? But, there are times when you may want to pay the higher price, for example, if you want the latest season’s purse rather than last seasons.

But enough about my purse addiction, let’s get back to bonds. If the bond matures at $1,000, a discount bond holder who bought at $970 will be pocketing $30 while a premium bondholder who paid $1,030 will be losing $30, right? Not exactly. The higher price a premium bondholder has paid is made up for by the higher interest payments they will earn along the way. In many cases, the additional cash flow more than pays for the cost of the premium price paid up-front. Take a look at the following example:

Additionally, due to its larger cash flows, the time it takes to repay the initial investment is shortened. With all else equal, the higher the coupon rate, the shorter the duration. As such, premium bonds can be more defensive in a rising interest rate environment and potentially less volatile. Also, this larger cash flow allows investors to reinvest more in new bonds to capture potential rate increase. By no means does this mean that premium bonds are immune to rising rates; however, they may offer a way to capture the higher yields with some degree of downside protection in a declining market.

So why pay a premium? In essence, there are a few advantages of buying premium bonds:

• Higher coupon rate

• Shorter duration to pay off your initial investment

• Less sensitivity to fluctuations in interest rates

• Opportunity to reinvest at a potentially higher rate.

Of course, there are additional risks and financial objectives that are personalized to each individual. Contact your financial planner to figure out how bonds may fit into your personalized financial plan!

Angela Palacios, CFP® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

DewRina Lee is an intern at Center for Financial Planning, Inc.®

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This information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete; it is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investments mentioned may not be suitable for all investors. Opinions expressed are those of Angela Palacios and DewRina Lee and are not necessarily those of Raymond James. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. There are special risks associated with investing with bonds such as interest rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment risk, and unique tax consequences. The example provided is hypothetical and has been included for illustrative purposes only, it does not represent an actual investment.

Investor Basics: Embedded Bond Features

Contributed by: Nicholas Boguth

This time around in our “Investor Basics” series, we’re going to take a look at the most common bond features. For a dive into a more complex bond pricing topic, check out our Director of Investment’s Investor Ph. D blog on why buying premium bonds can make sense.

First off, what is an embedded bond feature?

An embedded bond feature is a provision attached to a bond that changes its maturity, risk, or liquidity. A bond issuer may release a bond with an embedded feature in order to make it more attractive to a bond buyer, or to give itself a more favorable debt structure. The most common types of embedded features that you may have seen in the market, and that I will briefly go over in this blog, are call, put, and conversions.

Call features give the issuer of the bond the right to “call” the bond back from the bondholder at a specific date. This provision benefits the issuer because they are able to buy back debt, and then issue new debt at a lower interest rate. A company will typically issue a callable bond when they believe that interest rates will decrease in the future. Since this feature benefits the issuer, the company will have to make the yield or maturity more attractive to entice a buyer.

Put features give the bondholder the right to “put” the bond back to the issuer at a specific date before it matures. This provision benefits the bondholder because it allows him or her to put the bond back to the issuer (maybe interest rates have risen or the company’s credit is deteriorating). Since this option benefits the bondholder, he or she may have to accept a lower yield or longer maturity on the bond.

Another common embedded bond feature is the conversion option. This actually lets the bondholder convert the bond into shares of the company’s stock at a predetermined price and date. A company may issue convertible bonds as a way to issue cheap debt (they may not have to pay as large of a coupon because they are giving the bondholder the option to convert their bond to stock).

Each of these bond features may have a place in an investor’s portfolio, but knowing when and how to include them can be complex and differs from investor to investor. If you have any questions on these bond topics or any others, feel free to reach out to us at any time!

Nicholas Boguth is an Investment Research Associate at Center for Financial Planning, Inc.® and an Investment Representative with Raymond James Financial Services.

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The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Investments mentioned may not be suitable for all investors. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices generally rise.