3rd Quarter of 2018 Economic & Market Commentary

| October 19, 2018
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Have you ever been to a Red Sox game during the 7th inning stretch and thought to yourself, “This game seems like it has been decided- maybe I should leave now and beat the traffic?” Of course, you wouldn’t leave and risk missing a famous Red Sox comeback now that “The Curse” is long gone, but the passing thought is understandable.Have you ever been to a Red Sox game during the 7th inning stretch and thought to yourself, “This game seems like it has been decided- maybe I should leave now and beat the traffic?” Of course, you wouldn’t leave and risk missing a famous Red Sox comeback now that “The Curse” is long gone, but the passing thought is understandable.


As we enter the 112th month of the current economic expansion, the 2nd longest in U.S. history, investors can’t be faulted for considering a similar move to “beat the traffic” and move out of equities.  However, as we have continued to do in this newsletter, we would like to remind you that this strategy is likely to fail. After all, the market’s demise has been predicted by many over the years: Bill Gross in 2012, Marc Faber in 2013, Ron Paul in 2014, Paul Farrell in 2015, and Paul Krugman in 2016 highlight the list. We would suggest Googling “Chart of Shame” for an entertaining chart from MarketWatch.com. 


Robert Shiller recently shared a chart (pictured above) with JP Morgan which emphasizes the point that, just as the Red Sox may be saving their best for the late innings, so too may be the equity markets. In fact, if we looked at all market cycles, the 6 months prior to a market peak would have net you a 15% return on average, compared to just an 11% drop on average 6 months after the peak. To outline the math behind that, your $100 would rise to $115, then drop down to $102.35, leaving you ahead 2.35%. Getting out too early has its risks!  


Thus, we would encourage staying the course, especially given the slow and methodical approach being taken by the Federal Reserve to prevent run-away inflation.  This past quarter, the Fed raised rates for a third time by 25 basis points, placing it at a 2.0-2.25% range. While the 2008 recession was preceded by rising interest rates, the slope of these increases has been much more gradual than that 2004-2008 period. In September, employers added 134,000 jobs, bringing the unemployment rate down to 3.7%, its lowest rate since 1969. 


We like to keep an eye on valuations in this newsletter, as the price-to-earnings ratio of the S&P 500 has crept up to 16.8 versus the 25 year average of 16.1. It should be noted that the FAANG stocks – Facebook, Apple, Amazon, Netflix and Google (now Alphabet) – drastically bring this figure up. If we exclude those five stocks, the P/E ratio for the remaining 495 stocks is a more reasonable 13.3. Historically, most markets have been propped up by a handful of strong companies, which further emphasizes the importance of diversification. 


We would be remiss if we did not provide an update on the “trade wars.” President Trump announced a trade deal with Europe in July and a replacement for the 25 year old NAFTA agreement entitled the “United States-Mexico-Canada Agreement (USMCA)” to start October. The latter agreement made small changes that included opening up Canada’s dairy market to American farmers and ensuring that cars made in Mexico and Canada were made with a higher percentage of North American auto parts. 


More importantly, the agreements now allow the United States to turn its attention to China, where much larger issues exist. As it stands, the retaliatory tariffs put in place by China are minor in the grand scheme of things- Americans may see prices increase by 0.23% if businesses passed the entire increased costs to consumers. Larger effects are being seen in China where its stock market is down almost 20% year to date. It remains to be seen whether China and the United States will come to an agreement or if both will seek to align themselves more closely with their respective neighbors. With other issues arising in Turkey, Argentina, Brazil and South Africa, emerging markets are the lowest performing asset class in 2018, losing 7.4% year to date.  


In terms of investment returns, we continue to see a huge outperformance by U.S. Growth stocks (up 15.6% year to date) relative to all other asset classes.  Consider U.S. Value stocks (dividend payers) are up just 4.5% year to date while large foreign stocks are down 1.4%, emerging markets stocks are down 7.4%, and U.S. Aggregate Bonds (a major portion of diversified portfolios) are down 1.6%.


It’s no wonder then why diversified portfolios are generating just low single digit returns.  Consider the following benchmarks especially as compared to the headline return of 10.5% for the S&P 500 Index alone:


As we enter the home stretch of the 2018 calendar year, please consider contacting us to set up a review so we can begin the process of ensuring that your portfolio allocation and risk exposure is still appropriate to your overall personal and financial goals and objectives.

FIDUCIARY UPDATE

Many plan sponsors (employers) are unaware that they are fiduciaries as it pertains to their company sponsored retirement plans. An equal number of employers also believe that the retirement plan custodian and/or recordkeeper is a fiduciary—they are not! However, as your investment advisor, we are a fiduciary.

All of us at First National Corporation strive to maintain the highest standards of fiduciary practices and through our continuing education, we have achieved several professional designations to guide us in meeting our fiduciary objectives including AIF, QPFC, CFP and CRPS designations. But what do they all mean? We’ll explain…

Both Mike and Ken have earned the AIF® designation or Accredited Investment Fiduciary. The AIF program provides detailed instruction on how to comply with the fiduciary standards of care which includes 22 Prudent Investment Practices developed by the Foundation for Fiduciary Studies. These practices combine "the minimum requirements of pertinent legislation with industry best practices." Fiduciaries may be confident that they are meeting their obligations by holding to these practices. A client will benefit from using the expertise of an advisor with the AIF designation, as the advisor will be held to a standard of excellence to which others may not adhere.

Ken is also a QPFC® or Qualified Plan Financial Consultant. QPFC is the professional credential for financial professionals who sell, advise, market or support qualified retirement plans. The QPFC program provides an understanding of general retirement planning concepts, terminology, distinctive features of qualified plans and the role of retirement plan professionals. QPFC is for professionals who demonstrate a general proficiency of plan administration, compliance, investment, fiduciary, and ethics issues.

Alex is a CFP® or Certified Financial Planner. The CFP designation is awarded to individuals who successfully complete the CFP Board's initial and ongoing certification requirements. Individuals desiring to become a CFP professional must take extensive exams in the areas of financial planning, taxes, insurance, estate planning and retirement.

Alex also holds the Chartered Retirement Plans Specialist (CRPS) designation. The CRPS® is a credential for those who create, implement and maintain retirement plans for businesses. Unlike most other professional financial planning and advisory professional designations, the CRPS focuses on wholesale and business clients. It is awarded by the College for Financial Planning to individuals who pass an exam demonstrating their expertise.

A fiduciary is a person who acts on behalf of another person, or persons to manage assets. Essentially, a fiduciary is a person or organization that owes to another the duties of good faith and trust. The highest legal duty of one party to another, it also involves being bound ethically to act in the other's best interests. At First National Corporation, we take that duty seriously and as a result, we all strive to maintain the highest levels of education and professional qualifications.

If you have concerns about whether or not you are meeting your fiduciary obligations as a plan sponsor, please feel free to ask us for guidance.

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