Stocking Up

Posted October 22, 2017 by paragon. tags:Tags: , ,
Fall Time in the Park_opt

Written by Nathan White, Chief Investment Officer

How long will this upward move in stocks last? It’s a constant and valid concern, especially considering how well the markets have done for years. What will end the rally?

We are currently dealing with elevated valuation and sentiment levels, historically low volatility, rising interest rates, reversal of quantitative easing, terrorism, natural disasters, political uncertainty, and more. It is impossible to know what concern will finally “stick” and be the material cause for a correction. Sometimes markets just simply get exhausted to the upside. However, as there are always market concerns, being on the right side of the trend is more important. The current trend and economic indicators remain supportive of further stock outperformance. The market quite literally climbs a continual wall of worry. We will keep monitoring our models for indications of risk, but for now the weight of the evidence remains bullish.

If I had to pick my primary concern, it would be the potential effects from the Fed’s reversal of quantitative easing. The Fed’s quantitative easing actions (i.e. bond asset purchases) have provided tremendous liquidity to the markets. How long the markets will be able to move higher in the face of this withdrawal remains to be seen. There is usually a lag time for Fed actions to be felt in the economy and markets. As the Fed is starting slow, it may be some time before what is now being dubbed quantitative tightening (QT) has a material effect. We will watch the process with great interest.

On the constructive side, economic data continues to be positive globally. According to our indicators, recession is still not in the cards anytime soon. U.S. economic growth grew at 3.1% in the second quarter, which was slightly higher than expected. Manufacturing activity is the highest in 13 years and service-sector activity is the highest in 12 years. While stocks are expensive right now, they are not at extremes. Corporate profit growth remains positive and is offsetting the slow pace of rising interest rates. While interest rates are rising they are still extremely low on a historical scale. The prospect of fiscal policy being passed is still supporting the markets due to the potential economic shot in the arm it could provide.

Another positive is that we are heading into what is seasonally the best time of year for stocks. Additionally, the majority of global markets are trading above their moving averages, suggesting that momentum continues to support further gains.

Before this quarter, one of our concerns was that the breadth of the market advance was not very wide — only a few sectors and stocks were making up the bulk of the advance. However, last quarter alleviated some of these worries as the first half laggards such as small caps, energy, and value stocks rallied nicely. The final weeks of the quarter saw a rotation back into many of the “Trump trade” stocks.

Last quarter was good for the stocks in our Top Flight portfolio, which was up 6.3% for the quarter compared to 4.5% for the S&P 500 Index. Our stock portfolio is broken down into two segments and is currently comprised of 30 holdings of 2% each (60% total). The first is a fundamental based approach that focuses on stocks with the least downside risk. These stocks gained about 6.4% on average for the quarter. The second segment is a momentum or trend-based approach. The small cap segment of this approach was up about 11.2% and the large/mid-cap segment was up about 9.8% for the quarter. The best performers came from the auto parts industry with BorgWarner and Lear both up around 20% and 18% respectively for the quarter. Other good performers were building material companies such as Owens-Corning and Continental Building. Vertex Pharmaceuticals performed nicely after positive data on its cystic fibrosis drug. We also saw continued good performance from our aerospace and defense holdings of L3 Technologies, Northrop Grumman, Lockheed Martin, and Booz Allen Hamilton. Many of the small and mid-cap names did particularly well in September, accounting for much of the gain for the quarter.

Top Flight also includes two ETF based strategies. One strategy is based on a seasonality approach that rotates among various sectors and industries. It is comprised of three to five positions of 5% each. This strategy has been an underperformer this year and is only up about 2%. It was dragged down in the first half of the year by energy and retail exposure. While seasonality has been disappointing this year, it has been a good performer in prior years, sometimes attributable for the bulk of the gains in Top Flight. We still have confidence in this approach. The other ETF strategy is a single ETF momentum-based strategy, which is about 10 percent of the portfolio. This segment has had a single holding all year so far, the PowerShares QQQ, which is heavily weighted in technology. It is up about 22.5% for the year.

We are still grinding along in the Managed Income portfolio. Due to the low yields and the risk of extremely high prices, we are still keeping our powder dry. We are getting similar returns as the benchmark (for a lot less risk) and we are not locked into today’s low rates. Most broad-based bond funds or conservative portfolios are comprised of various mixes of longer-dated bonds. As interest rates rise, the losses on those bonds will offset the meager yields offered. Most fixed income funds or portfolios are sitting on a pile of future potential losses. There is no avoiding the dilemma, and even if interest rates didn’t rise they would be stuck with their current low yields. Therefore, we have minimized our exposure to longer-dated bonds. We believe our portfolio to be more conservatively positioned. We still prefer shorter maturity bonds, and as interest rates have risen their yields have improved. Short maturity bonds allow us to increase our yields as interest rates rise without getting hit with capital losses. While we know it is hard to accept low returns, it is better than reaching for yield and taking bigger risks like so many investors are doing. Don’t succumb to the desperation many are giving in to! Yield chasing can be hazardous to your financial health. It’s better to get a lower, more stable return than to put too much at risk.

Disclaimer: 1. Investment performance reflects time-weighted, size-weighted geometric composite returns of actual client accounts. 2. Investment returns are net of all management fees and transaction costs, and reflect the reinvestment of all dividends and distributions.  3. The S&P Index is a market-value weighted index comprised of 500 stocks selected for market size, liquidity, and industry group representation The Barclays Aggregate Bond Index is a benchmark index made up of the Barclays Government/Corporate Bond Index.  4. Benchmarks are used for comparative purposes only. The Paragon Top Flight Portfolio is not designed to track the S&P Index and will have results different from the benchmark. The Paragon Managed Income Portfolio is not designed to track the Barclays Bond Aggregate Index. 5. Past performance is no guarantee of future results. Investments in securities involve the risk of loss. Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

Keep On Keeping On

Posted October 15, 2017 by paragon. tags:Tags: , ,
Fall Mountains-1

Written by David Young, President and Founder of Paragon Wealth Management

Last quarter was a continuation of what has gone on since last year’s election: The markets keep going up. Leadership changed and rotated to Small Caps taking the lead this quarter. Small Caps lagged in the first quarter (and again in August), but then took off in September to get back in line with the other averages.

The leading indexes change from quarter to quarter, rotating between the S&P 500, the NASDAQ, Emerging Markets, International Markets and Small Caps. But the bottom line is that the market trend is up.

Assuming your investment strategy is sound, this past quarter proves the “long term argument” of waiting patiently for your strategy to pay off. Our portfolios continue to provide good performance.

I am repeatedly asked, “How long can this market keep going up?” and “With all of the problems and concerns, why does the market keep going up?”

Regarding “how long,” no one knows for sure. We are currently breaking records for the period of time we have gone without a correction. Based on our models, the market is fully valued. We are to be cautious — but still stay invested.

History shows that markets can continue going up even when they are at full value. Last year, before the election, many pundits recommended jumping out of the market. Sadly, they are now significantly behind and are still waiting for their opportunity to get back into the market. Others got out during the 2008 Crash … and have still never gotten back in. The markets are seemingly biding their time and waiting for earnings to catch up with stock prices. Usually, you would have seen a sell-off by this stage in the cycle.

THREE PERCENT GROWTH 

To answer the question of why the market is going up, I’ve pulled some content from a recent article in the Wall Street Journal by Phil Gramm and Michael Solon. They were making an argument unrelated to the stock market, but I will use talking points from their article to explain the “why.”

Stock valuations are based on their underlying earning power. When companies are expected to make more money, their stock price goes up. Conversely, when companies are expected to make less money, their stock price goes down.

Complicating things, stock prices are not necessarily based on what is actually happening; they are based on investor expectations.

Looking at the big picture, GDP is a measure of the growth of the U.S. economy. In the postwar era, the U.S. averaged 3.4% annual growth from 1948 through 2008. We averaged 3% growth for half of the George W. Bush presidency (2003-06).

Only with 3% or higher growth does America experience measurable progress in poverty reduction, strong job creation and income growth.

Many talking heads argue that the days of 3% growth are gone and that America’s economy has lost its ability to grow at 3% above inflation.

From 2009-12, the Obama administration, the Congressional Budget Office and the Federal Reserve all thought they saw 3% growth just around the corner. If the possibility of 3% growth is gone forever, it hasn’t been gone very long.

America enjoyed 3% growth for so long it’s practically become our national birthright. Census data show that real economic growth averaged 3.7% from 1890-1948. British economist Angus Maddison estimates that the U.S. averaged 4.2% real growth from 1820-89. Based on all available data, America has enjoyed an average real growth rate of more than 3% since the founding of the nation, despite the Civil War, two world wars, the Great Depression and at least 32 recessions and financial panics. If 3% growth has slipped from our grasp, we certainly had it for a long time before we lost it.

During the Obama presidency, growth slipped to an unbelievable low of 1.47%. As a result, many Americans believe 3% growth is gone forever.

Phil Gramm argues that most of the growth constraints we face today are directly attributable to the Obama era policies. The Bureau of Labor Statistics reports that labor-productivity growth since 2010 has plummeted to less than one-quarter of the average for the previous 20, 30 or 40 years. Productivity fell during the current recovery, not during the recession. With high marginal tax rates, especially on investment income, new investment during the Obama era managed only to offset depreciation, so the value of the capital stock per worker, the engine of the American colossus, stopped expanding and contributed nothing to growth.

A tidal wave of new rules and regulations across health care, financial services, energy and manufacturing forced companies to spend billions on new capital and labor that served government and not consumers. Banks hired compliance officers rather than loan officers. Energy companies spent billions on environmental compliance costs, and none of it produced energy more cheaply or abundantly. Health-insurance premiums skyrocketed but with no additional benefit to the vast majority of covered workers.

In 2006, when the labor force participation rate was 66.2%, the BLS predicted that demographic changes would push it down to 65.5% by 2016. Under Mr. Obama’s policies, it actually fell further, to 62.8%, and the number of working-age Americans not in the labor market spiked to 55 million.

By waiving work requirements for welfare, lowering food-stamp eligibility requirements and easing standards for disability payments, Mr. Obama’s policies disincentivized work. Disability rolls have expanded 18.6% during the current recovery, compared with a 16% decline during the Reagan recovery.

If reversing the Obama era policies simply eliminated half the gap between the projected 1.8% growth rate and the average growth rates during the Reagan and Clinton recoveries, it would deliver 3% real growth generating nearly $3.5 trillion in new federal revenues over the next 10 years.

Since 1960, the American economy has experienced 30 years with growth of 3% or more. Seventy-nine percent of all jobs created since 1960 were created during those years. The poverty rate fell by 72% and real median household income rose by $20,519. In the 26 years when the economy had less than 3% growth, just 21% of all post-1960 jobs were created, the poverty rate rose by 37% and household income fell by $12,004. With 3% growth, the American dream is achievable and virtually anybody willing to work hard can live it.

BOTTOM LINE 

If you listen to the national narrative about how scary and awful things are, it makes no sense why the market continues to go up.

On the other hand, when you understand that as a result of our last election, most investors “expect” that there will be major tax, healthcare and regulatory reform that should take us back to the policies that brought us 3% growth, the upward market trend starts to make sense.

As always, let us know if you have questions or need anything from us.

Disclaimer: 1. Investment performance reflects time-weighted, size-weighted geometric composite returns of actual client accounts. 2. Investment returns are net of all management fees and transaction costs, and reflect the reinvestment of all dividends and distributions.  3. The S&P Index is a market-value weighted index comprised of 500 stocks selected for market size, liquidity, and industry group representation The Barclays Aggregate Bond Index is a benchmark index made up of the Barclays Government/Corporate Bond Index.  4. Benchmarks are used for comparative purposes only. The Paragon Top Flight Portfolio is not designed to track the S&P Index and will have results different from the benchmark. The Paragon Managed Income Portfolio is not designed to track the Barclays Bond Aggregate Index. 5. Past performance is no guarantee of future results. Investments in securities involve the risk of loss. Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

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