Not What Anyone Expected

Posted January 20, 2018 by paragon. tags:Tags: , ,
Snow Trees_opt

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

Two-thousand and seventeen was a banner year for stocks. Not just in the U.S., but around the world. Investors with a long-term perspective were rewarded once again.

It was not a good year for the market forecasters. Their primary talent is consistency — and they were consistently wrong.

At the beginning of last year, most Wall Street Strategists forecasted a gain of 4% or less for the upcoming 2017. The actual gains were five times more than those projections. Following their advice would have been disastrous.

Between U.S. tensions with North Korea, the new presidential administration, and the state of politics in America, the forecast was increased market turmoil. Instead, we saw a calm in the markets we had not seen in decades. The VIX, which is a measure of market volatility, unbelievably closed below a level of “10” more times last year than any other year in its history.

In addition, the forecasts regarding global growth and inflation were off base. If you have been a client for a while, you understand why we never invest based on market forecasts.

Successful investors, on the other hand, focused on the upbeat fundamentals. Corporate profit growth was sparked by economic gains at home and abroad. The political push to decrease regulations and effectively free the “free market,” combined with the recently passed tax plan, increased positive expectations even more.

The U.S. economy grew at 3.3% in the third quarter. That was the second quarter in a row the GDP exceeded 3% — a feat that hasn’t occurred in three years. Even more impressive, fourth quarter estimates by the NY Fed expect GDP to come in at almost 4%, which is higher than anyone previously forecast.

The S&P 500 performance reflected the strength of the economy and was positive every single month in 2017. That has not happened since 1970.

PARAGON PORTFOLIOS 

An interesting surprise with this year’s rally is how many individual investors did not benefit from it. Throughout the last nine-year surge, after the devastating market of 2008, individual investors have continuously pulled money out of funds that own U.S. stocks. Nearly $1 Trillion has been pulled out since the start of 2012, according to EPFR Global, a fund tracking firm.

From a trading perspective, this has been a difficult market. Why? When markets consistently go up they don’t require a lot of trading. They require you to be in the right place and hang on.

Additionally, straight up markets, like the one we experienced last year, create false confidence amongst investors. Many people decide they are investment geniuses. And they are … until they aren’t anymore.

Investing based on luck, without a strategy, is impossible to replicate. Since no one knows in advance when the market is going to go up, go down, or run sideways, relying on luck rather than strategy eventually catches up with investors. Just like the temporarily successful gambler, it is just a matter of time before they implode and suffer significant losses. As the saying goes, no one rings a bell at the top when it is time to sell.

And then there were Bitcoin experts this holiday season. They sought me out at seemingly every event I went to. But they had a puzzled look on their face when I asked them to explain exactly “what” it was that they were investing in, or why their Bitcoin fortune would vanish if they lost their account password.

Another axiom we dodged this year was that traditional wisdom of “sell in May and go away.” If we had done that, we would have missed significant gains between May and November. That was another obstacle that could have cut your returns by more than half. Fortunately. our models kept us invested all year.

Overall, we were pleased with our portfolios. All performed well in the context of the risk level they are invested in.

Managed Income acts as the anchor to the portfolios. As long as interest rates stay pushed to the floor, its returns will be relatively low, but still better than bank rates. On a positive note, it looks as though we may see an increase in rates this year, which should help Managed Income. Regardless, its primary purpose is to provide stability for our portfolios.

Top Flight, with all of the changes we made a year ago, performed well. If you would like more detail on the three portfolios — momentum, fundamental and seasonality — that make up Top Flight, give us a call and we will happily walk you through them.

The new Balanced Portfolio and the two Private Funds both had a strong performance this year as well.

GOING FORWARD 

Our Consumer confidence or individual optimism is the highest it has been in 17 years. Investor sentiment is also the most bullish it has been as far back as we are able to track it.

This puts us in a tricky spot. Historically, we know that as investor sentiment moves higher we are approaching a market correction. The theory is that once everyone who is going to invest is invested, there is no one left to push the market higher.

The difficulty with market sentiment as an indicator is timing — you don’t know exactly when such a correction will occur. As a result, we are also watching internal market technicals but with a more skeptical eye than normal. Trend indicators, Advance/Decline lines, Industry Breadth, etc. all still look good.

Last year we updated Top Flight with our best individual stock models. In an effort to match or exceed the returns of the broad markets, we tied Top Flight’s more directly to those broad markets than we had historically. Our belief is it is better for Top Flight to accept more short-term downside volatility so that its returns over the long term will increase.

With this year’s market strength, along with the changes we made to Top Flight last year, it is important to correctly set the amount of volatility you are willing to accept. We can effectively reduce your overall volatility by decreasing your exposure to Top Flight and increasing your exposure to our more conservative portfolios. Getting that right is one of the pillars of investment success.

If you would like to talk about how you are positioned or make any changes, please give us a call. We are always happy to hear from you. Have a great 2018!

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.

Calm Seas?

Posted January 10, 2018 by paragon. tags:Tags: ,
Pier at Sunset_opt

Written by Nathan White, Chief Investment Officer

For the stock market, 2017 was a year of unprecedented smooth sailing. The S&P 500 has risen for 14 months straight, a new record. It also didn’t have a monthly decline, which has never happened before. Volatility was non-existent. The economy continues to move along with no signs of an imminent recession. Moreover, there have been no corrections in sight.

The latest global manufacturing indexes (PMIs) ended with the strongest reading in nearly seven years. Many of our forward-looking economic indicators also point to even faster growth in the coming months. New orders and export orders are at their highest levels since early 2011. The ratio of new orders to inventories matched its strongest level since June 2014. Backlogs are at the highest point since May 2010. On the back of this strong data, job growth looks set to expand further. (Source: NDR – Economics, Global Comment, 1/3/2018) 

Price pressures are strong but have not exploded, which means inflation is still modest. In 2018, we will be watching to see if the tax cuts and possible infrastructure spending will push inflation expectations higher. Interest rates are still low overall, but moving up. The bond market could become a problem in the coming year (more on that later). Other risk factors coming from our models are high equity valuations and extremely optimistic investor sentiment. Most of our models are still positive, so it remains a bull market until proven otherwise.

2017 REVIEW 

The best performing areas of the equity market last year were large-cap stocks, growth stocks and the technology sector. Small-cap and value stocks, while still up for the year, lagged the broader market. It will be interesting to see if value stocks make a comeback in 2018.

Top Flight had good performance being up 18.5% for the year. It was up about 11.9% for the last six months of the year, which was about a half percent better than the S&P 500 after fees. As you know, in 2017 we started taking individual stock holdings that comprise about 60-64% of the Top Flight portfolio. We have been pleased with the result. Our stock holdings overall averaged nearly 21.5% for the year. The stock portfolio is broken down into two segments. The first is a fundamental-based approach that focuses on stocks with the least downside risk. These stocks performed well and were up about 25.5% for the year. Considering these stocks have somewhat of a value/quality aspect, this was an impressive showing. The second segment of our stock holdings is a momentum or trend-based approach. This segment was up just shy of 18% for the year. Within this segment, the small-cap names did the best, particularly in the last half of the year. Overall, the best performing individual names were Home Depot, United Health Group, Domtar, Owens Corning, and Northrop Grumman.

Looking ahead for 2018, we like the valuation position of our equity holdings. The forward PE (price/earnings) multiple of our stock holdings is about 16.8 versus 19.8 for the S&P 500. This means our current holdings are about 15% cheaper based upon projected earnings for next year. Not a bad place to be after the significant upward move in equities.

Top Flight also includes two other strategies based on ETFs. One strategy is a seasonality approach that rotates among various sectors and industries. This strategy comprises 20-25% of Top Flight and was up about 11% for 2017. While up for the year, seasonality was our weakest performing strategy last year. However, in the prior three years it was our best performing ETF strategy. Our approach with Top Flight is to diversify by strategy. No strategy will outperform every year, and due to its solid long-term record, we still have confidence with the seasonality method. The second ETF strategy we employ is a single ETF momentum-based strategy. This strategy, which comprises 10% of Top Flight’s allocation, performed well on the year and was up over 25%. Most of this performance came from the PowerShares QQQ, which is heavily weighted in large-cap technology.

On the conservative side, our Managed Income portfolio had a net return of about three percent. Still not ideal, but we are constrained by the environment of low yields. We achieved similar returns to our benchmark, but with a lot less risk to rising interest rates. To get a higher return, we would have had to load up on risky debt, which would have only produced an additional 1-2% return. Not worth it in our estimation. We still do not recommend long-term bonds. The bond market is getting backed into a corner. As interest rates rose last year, it was short-term rates that moved up while the yields on longer maturity bonds didn’t move (or went down slightly). The difference in yield between the two and 10-year Treasury bonds is now only about a half percent. The Federal Reserve is set to raise interest rates another 0.75% to 1% next year. If longer maturity bond yields do not start going up, it won’t take long for short-term bond yields to exceed them. This is called an inverted yield curve and is often a harbinger of recession. If longer maturity bond yields do move up with the Federal Reserve actions, then 10-year Treasury could lose at least 5%, and longer maturities 15% or more. Because of these dynamics in the bond market, we are not as exposed to interest rate risk as most bond portfolios. We don’t hold any maturities longer than 10 years and the Treasuries we do hold are a hedge against any possible stock market correction. Keeping most of our fixed income exposure to shorter-term maturities allows us to increase our yields as interest rates rise without getting hit with significant capital losses.

MAKE HAY WHILE THE SUN SHINES 

The roaring stock market offers investors an opportunity to review their asset allocation. Now is the time to rebalance — not when the inexorable correction comes. Most have the tendency to put money into whatever has been doing well. To keep the proper risk exposure, investors should trim their exposure to stocks as stocks increase. One of my favorite axioms is to take what the markets give you, but unfortunately, investors have short memories. The increase in the stock market has simultaneously increased allocation to stocks. When the correction occurs, those who have not re-allocated will take a bigger hit to their portfolios than they can actually stomach. Please contact us if you would like to re-view your allocation.

We appreciate your trust and business and wish you a prosperous and happy 2018!

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.

Blog Role

Meta