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Investment Outlook – JULY

The World, the U.S. and the Markets

Overview

  •   The U.S. economy is in divergence from the economies of Europe and China.
  •   Europe is growing more slowly than the U.S. and now faces the added stress of the   British exit from the EU.
  •   China continues to slow and is now beset by institutionally driven over-capacity.
  •   The U.S. consumer should keep the U.S. economy moving in a positive direction.
  •   The markets were shaken by the news of the “Brexit” vote, but were not crushed.Volatility should continue at a high level.
  •   Stocks are not cheap, but are also not wildly overpriced.
  •   Bond yields are extremely low and long dated fixed income asset prices are particularly vulnerable to potential increases in interest rates.
  •   Cash equivalents provide stable value, but little or no yield.

  The stock market shows resiliency, bouncing back from stressful events like the “Brexit” vote. It may be the most attractive of the investment choices. However, we recommend employing cash and short to intermediate term bonds to dampen volatility.

There once was a time when all we needed to know about the economy occurred within the confines of our national borders. Then, the free world was rebuilding itself from the devastation of World War II and the U.S. was the building supply company, bank, grocery store and general merchandiser to the world. There was no U.S. trade deficit. That was over fifty years ago and the global economy has changed dramatically. The U.S. is no longer the sole driver of economic growth, not because it has stopped growing, but because the rest of the world has recovered from the war, developed and learned how to compete. Today, the three largest world economies are the European Union, the U.S. and China, in that order. Over the last forty or so years, the domestic U.S. economy has become increasingly linked to the economies of its trading partners, both overseas and across borders. Despite the entangling nature of this process and the inevitable economic correlations that occur on a global basis, there are always divergences. The major divergence that exists today is between the U.S. economy and the rest of the world. While the U.S. economy appears to be somewhat healthy (despite a looming debt burden and entitlement liabilities, we do have low unemployment and positive GDP growth), the economies of both China and Europe face serious stress.

The news from Europe that the United Kingdom has voted to leave the European Union is a particularly distressing development in a region that has already experienced its share of challenges. Although GDP in Europe has been increasing for over three years, it has been at a slower pace than that of the U.S. and has required the European Central Bank to maintain interest rates at even lower levels (zero to negative) than has the U.S. Federal Reserve. Most of the growth has come from Germany and France while Greece, Italy and many of the peripheral members of the EU have been languishing in recessions. Terrorism and the flood of migrants from Syria and Africa have strained the budgets of many of the weaker nations, many of whom were already weakened by the raft of austerity measures imposed by budget hawks in Brussels. The news that the U.K. is giving up on the EU has a profound psychological effect on the continent and the world. The actual exit cannot occur for at least two years and there are many negotiations that must occur before anything becomes final. But, since one interpretation of economics is mass psychology expressed through markets, the “Brexit” vote itself may be enough to depress global and European growth.

On the other side of the world, China’s GDP has grown almost eightfold — about 9% a year — over the last twenty-five years. Nevertheless, the People’s Republic of China is now facing some of the paradoxes inherent in that almost oxymoronic state, a planned capitalist economy. In allowing some decentralization in its provinces, the central committee emboldened and monetarily encouraged local bureaucrats to develop infrastructure and products for China’s bright new future. This effectively created thousands of “capitalist roaders” without a market discipline to moderate their acquisitive instincts. The first result of this ill-conceived program was over production of housing, transportation, municipal services, infrastructure, capital goods, consumer products and debt. This, of course, led to the dumping of consumer products and capital goods on international markets. The next result has been high unemployment, intolerable in a worker’s paradise, and a restive population. A rebellion is highly unlikely, but there will continue to be corruption trials and other assignments of blame. In short, China’s growth rate will not return to 9% anytime soon and appears to be headed south of 6%. This retrenchment will continue to place downward pressure on the economies of the developed and developing world.

Unlike the U.S. of yesteryear, the domestic economy is not totally immune to these international stresses. Although the U.S. has run a trade deficit for most of the recent past, close to 50% of S&P 500 earnings come from non U.S. sources. Weakness in foreign demand and the relative strength of the dollar during the current period of international stress have taken a toll on corporate income statements. Though declines in corporate profits have no direct impact on GDP, declines in the international sales of large U.S. corporations do have a negative impact on capital expenditures, a component of GDP, and on hiring. Capital expenditures by non-energy companies have remained weak throughout the current business expansion. And payroll employment has recently slowed to an increase of only 38,000 in May from an average increase of 155,000 in the prior two months. Labor productivity — output per hours worked — is strongly influenced by corporate expenditures on more efficient capital equipment; in the first quarter of 2016 — the most recent report — productivity declined by .6%. It remains to be seen if the decline in payroll employment and productivity is only a statistical blip, a sign of an aging expansion or the result of an absence of capital investment due to corporate timidity. We prefer to believe in the latter explanation, but the current expansion is a little long in the tooth (eight years) and well past the time when corporations normally would ramp up capital expenditures. If the economies of Europe and China deteriorate and drift into recessions, it would increase the odds that the U.S. might experience a similar fate. We don’t believe that this will happen, at least not in 2016, even with the fear-inducing issues in Europe and China. The main reason for our optimism is the consumer.

Despite the benefits to the U.S. of improving foreign trade and the negatives associated with a shrinkage in international transactions, the U.S. is not an export driven economy. More than two-thirds of the U.S. economy comes from consumer spending, and the consumer is doing well: unemployment is below 5%, payroll employment continues to improve (despite a disappointing May number), salaries are finally growing, housing starts are averaging over 1100 per month, gasoline prices are almost 40% below where they were five years ago, interest rates continue to favor the borrower, retail sales remain strong and inflation is still quiescent. In the spirit of “it’s an ill wind that blows no good”, the “Brexit”-induced global angst has created some benefits: the Fed is likely to postpone again an interest rate hike and dollar strength has lowered prices on imported goods. The U.S. has its issues – an aging population, exploding national debt due to out-of-control retirement benefits – and the payroll employment numbers will bear watching, but as long as the consumer remains optimistic, economic troubles overseas should not derail the progress of the domestic economy.

In the financial markets, the news of the British vote hit like a bombshell. Despite warnings that the vote would be close, most investors believed that the British people would never do something so un-British as to jump off a cliff without considering the consequences. The vote was probably prompted by immigration concerns and fears of vanishing British sovereignty, but the result was a clear negative for those who support globalization and the expansion of world trade. On the day the results came in (Friday, 6/24), the S&P 500 dropped 3.6% and yields on U.S. Treasuries dropped to the lower levels of their recent ranges. The damage continued on the second day of trading (Monday, 6/27), but by the third day Tuesday (6/28), the markets began to recover. Despite all the excitement, trading remained orderly and there were few glitches in computerized systems. It was the worst one day decline since last August, but only brought us even with the previous week’s close. It certainly didn’t compare with some of the more horrific declines of the last ten years. And it was definitely not a “crash”. Nevertheless, dramatic market events usually produce aftershocks for days and weeks following the first impact: we expect to see heightened market volatility well into July.

It is difficult to muster great enthusiasm for any investment market as we approach the dog days of summer. Stocks, while not wildly expensive on a valuation basis, certainly aren’t cheap. Price/earnings multiples are high relative to the averages over the last ten years, but not when compared with the averages over the last sixty years. They certainly are discounting more earnings growth than is justified based on recent history: corporate profits have declined for each of the last four reported quarters and analysts’ expectations are for a decline in the quarter just ending (Q2, 2016). Dividend yields look very attractive when compared with the yields on ten year bonds, but most things do.

Bond yields are at absurdly low levels everywhere but in the higher risk categories. Despite our inclination to believe that interest rates will never rise again, we know they will. When they do, bond prices will plummet for even the highest rated bonds. (We should note, however, that if interest rates increase because of quickening economic activity, lower rated credits (junk bonds) may increase, instead of decline, in price.)

And what can we say about cash? As low as yields are on bonds, they’re even lower on cash equivalent securities. Central banks everywhere have pushed yields to zero and beyond in order to curtail savings and stimulate borrowing and spending. American investors can take some comfort in the knowledge that at least dollar denominated cash investments are yielding above zero.

It’s possible to make an argument that stocks, particularly U.S. stocks, are the most attractive investments among the three traditional asset classes. Despite all the clear evidence of stress and weakness across the globe, U.S. equities have generally held onto their somewhat elevated prices. Even the “Brexit” vote was not enough to shatter the optimism of investors, though it did cause many to doubt. There’s an old saying on Wall Street that one shouldn’t fight the tape. If it has any meaning, it is that the market has a better sense of where the future lies than pundits and opinion makers. We would agree that the market is prescient, but we also know that it’s not infallible.

Investors who remain fully invested in stocks will likely be rewarded with higher prices and better returns over the long run, but they will also experience a good bit of volatility and the fear that they might be wrong. Within the allocation guidelines that are appropriate for our clients’ long term goals, we recommend maintaining a meaningful equity position, but we also advocate a healthy dose of volatility dampening investments: cash equivalents and short to intermediate term fixed income securities. The weeks ahead could produce more fireworks than just those on the Fourth of July.

Not Investment Advice or an Offer This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing.

For more information about the commentary found in this post, please contact a member of the investment committee.

Generational Management

by Kevin Karpe, Heritage Trust

Kevin KarpeWhen I was 25 years old and new to the business, I served as a trustee for a 90 year-old Holocaust survivor. That experience not only changed my view of what it means to administer trusts, but helped shape my view of the world. She asked that we get together on a weekly basis to talk about her investments, but when I’d come to see her, I would have two bottles of wine with me. One to drink, one to last her through the week. She explained so much more to me than I would have ever been able to explain to her. Twenty-five years and a couple of generations later, I’m still administering a family trust and repeating those stories the grandmother entrusted to her family.

As relationship managers, we take our duty very seriously. There’s more to managing a relationship than can be contained in the four corners of a document. We take time to get to know our clients very closely. It’s our obligation to understand the expectations of a grantor while recognizing the needs and aspirations of the beneficiaries. In a nutshell, we spend our days transferring wealth, as well as values, to the next generation.

My enjoyment comes from working with families, often over multiple generations. A relationship with a family can be short and simple, like administering an estate over the span of a few months, or last for decades, like managing a trust for grandchildren.

We ask our clients, “What legacy do they want to leave?” Not necessarily spending or budgeting or asset management, but what are your values and what values do you want pass on?

A common mistake clients can make is drafting a trust document and then not readdressing the overall plan when there’s a big life event such as a divorce, a child graduates from college or reaches a certain age. Those are all good opportunities to readdress your intent and adjust accordingly.

When it comes to selecting a fiduciary to work with, I think it’s important to look at the following things: Experience. Independence. Rapport. Clients need to have confidence in the institution as a whole and look at their history.

As a relationship manager, I look forward to the unique life stories and legacies each client brings and figuring out how we can do our part to pass on that legacy.

Kevin Karpe is senior vice president, relationship management, for Heritage Trust.  You can read more about Kevin here and contact him anytime at kkarpe@heritagetrust.com.

The Greatest Gifts

by Phil Buchanan, Argent Financial Group

My mother was born just prior to the stock market crash of 1929 and the ensuing Great Depression. Although only a child during this period, she quickly learned to be a good steward of finances. It was a trait that followed her for the rest of her life. It was also something that she sought to instill in my sister and me. I can now look back and realize that her teachings with regard to the honor and value of work, of the necessity of saving and investing, and of the nobility of philanthropy, were among the most important and greatest gifts she gave to me.

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In a society where financial information is more readily accessible than ever, I observe many families who are not engaging their rising generations in meaningful conversations with regards to wealth, its purpose, its capacity and its stewardship. While the immediate risks of not engaging in such dialogue are limited, the longer term impacts can be quite negative.

At an appropriate age (most professionals tend to suggest between 14 and 17), children of families with means need to be brought into discussions as to the foundational beliefs and values that the family shares with regards to wealth. A basic primer on the structure (not value) of the family’s wealth situation (business interests, core portfolio holdings, royalty interests, etc.) is usually advisable at this time as well.

As children continue to demonstrate interest and maturity towards learning more, these discussions and teachings should continue. One of the greatest risks a family can take with regard to wealth is failing to educate and prepare future generations. With a bit of effort and patience along the way, you can ensure proper stewardship of wealth for generations to come.

Good News About Retirement

by Brad Knowles, Heritage Institutional

When 401(k) plans were introduced in the marketplace in the 1970’s, they were designed to allow highly compensated workers to put more money away for retirement. This is because the traditional pension plan was still the dominant retirement plan at employers. Today, 401(k) plans are the primary retirement savings vehicle. The move from pension plan (employer funded) to 401(k) plans (employee funded) means we are now using a wheelbarrow to do the job of a bulldozer.Brad Knowles

The word “retirement” is in the news almost every day. Every newscast shows how the Dow, NASDAQ, and S&P 500 performed, but what does it really mean?

  • Approximately 8,000 baby boomers turn 65 years old every day.
  • Social Security is designed to replace approximately 25% to 30% of a working couples income.
  • The average couple will need just over $200,000 to cover their healthcare cost
    during retirement.
  • 68% of Americans between the ages of 50-64 report their biggest worry being not having enough money for retirement.

For most, it is not a question of if they retire, but how long can they afford to stay retired.

Now comes the good news….

There are ways to make our wheelbarrow work more like a bulldozer. We know that
workers need to put between 12% and 15% of salary away each year. When combined with social security and time, this formula should replace about 75% to 80% of the average workers income, with approximately have of that coming from retirement savings.

We know the average worker is not going to just accidentally start saving 10% of pay. We, as employers, have to be courageous. We have to automatically enroll our employees in the plan. We have to automatically increase their deferral incrementally over time. We also need to change our viewpoint on matching funds. We need to optimize the match to encourage/reward higher deferrals. Optimizing the match means matching 40% to 10% instead of 100% to 4%. If we optimize the match, employees will be more satisfied about increasing their contributions.

Studies show that less than 10% of participants that are automatically enrolled in the plan opt out. Over time, we can change the culture. We would love to see 90% participation in retirement plans, 10% average deferral rate, and 90% utilization in professionally managed investments.

Retirement means many different things to different people. To some it means changing vocations, to others it is not working, and yet to others, it means a time to volunteer. To Heritage, retirement means the opportunity for our clients to have those choices.

Argent Mineral Management Opens Office in Southlake, TX

We are pleased to announce the opening of our Argent Mineral Management office in Southlake, Texas with Rosie Calvillo and Buffie Campbell.

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Heritage Wealth Management and Argent Financial Group are pleased to announce Buffie Drennan-Campbell, JD, CPL, and Rosie Calvillo, RL, are leading our latest expansion in Southlake, Texas specializing in oil, gas and mineral management.

With over 20 years combined experience, Buffie and Rosie are dedicated to building and maintaining relationships in the D/FW area through proactive communication, creative and unbiased solutions, and dependable, responsive service.

At Argent, we understand that every mineral transaction is distinct. With backgrounds rooted in law, trust and mineral asset management, our Southlake office can provide specialized attention to meet the most unique of needs.

Argent Mineral Management
1256 Main Street, Suite 219
Southlake, TX 76092
817.809.8012

ArgentFinancial.com
HeritageTrust.com