Recent Market Decline and Rebound
One year ago, the Federal Reserve was aggressively increasing interest rates, and the stock market plunged by almost 20%. The market interpreted the interest rate signal from the Fed as a one-way ticket to a full-blown recession in the Winter of 2019.
In early 2019, the Federal Reserve reversed interest rate policy in light of weakening economic data. They began a series of rate cuts through the Fall of 2019. However, while the economy weakened somewhat, the GDP numbers settled into a range where growth dropped back to about 2% growth per year. 2% growth was a return to the economic growth rate under President Obama.
Our position at Compass Rose a year ago was that we did not foresee a recession. However, we did acknowledge a slowing of U.S. growth. Our view was that 2019 was going to be a year where earnings growth would continue and market prospects were bright. In December of 2018, we had raised considerable cash in our portfolios and we began to put the money to work the day after Christmas when stocks were relatively inexpensive. The result was that portfolio values climbed for four straight months. In May 2019, we had a market pullback which was barely noticed by the media covering financial markets. After a month-long down period, stocks resumed their upward climb, peaking in late July.
As the market hit all time highs, market forces became concerned about a tariff war with China and possible lower corporate earnings. The market sold off and remained volatile through September. The selloff was relatively tame, but most of the media proclaimed the start of a recession! They could not have been more wrong. While corporate earnings slowed, third quarter earnings announcements were better than expected. It was simply normal ebb and flow of a market cycle.
Throughout August and September, we identified significant market rotations where growth stocks fell out of favor and value stocks gained support. We began a restructuring process in our portfolios to add high quality value stocks. But we retained our high conviction growth stocks as well. The value stocks performed well in September. However, there was a reverse rotation back into growth stocks in October. Thus, our high conviction growth stocks began to fuel higher portfolio returns.
Overall, the stock market rallied right back to all-time highs. Today, as we review our portfolio results, we see that all nine of Compass Rose’s portfolios are beating their target return numbers, plus outperforming their market benchmarks. Our patience has paid off. And, our belief that recession was media-fed-fear was sustained.
We are now concluding the third-quarter earnings season and earnings have been stronger than anticipated by the “experts” (stock analysts). Given the forward guidance from corporations, the financial media are suggesting that we are returning to a 2% growth estimate for the 2020 U.S. economy. We tend to agree on this point. And, despite the Tariff Wars, Impeachment, 2020 elections, and economic slowdowns in Europe and China, we are fairly optimistic that things may just work out fine in the coming year.
Our plan is to continue to study the markets every day and adjust our strategy as necessary. If we maintain our 2019 portfolio gains, 2019 will be a huge up year. Given these above-average gains, we foresee 2020 as a return to average market gains. But beware! The next round of negative market commentaries will arrive soon. We see sensational stories every day about an imminent market collapse. Our advice is to remain calm, have patience and monitor what we are doing to manage your assets in changing times. Above all, please remain confident that when the markets face real downward pressure, we will act to protect the value of your investments as best we can.
2019 Taxable Accounts – the Taxman is about to visit
During the last eleven months, our portfolio management has resulted in the creation of significant realized capital gains in taxable accounts. This is especially true in the Long-Term Growth and Aggressive Growth Portfolios. Normally, we would begin tax loss selling at this time of year to attempt to offset the gains. Unfortunately, there are almost no unrealized losses in the portfolios that could be harvested to offset the gains. Consequently, for clients with taxable accounts, we are very likely looking at some additional taxes for 2019. If you have a concern about your taxable account(s), please call us for an estimate of your gains and we can help determine the potential tax bill with the help of your CPA. And, perhaps your CPA can recommend ways to moderate the impact elsewhere in your tax return.
Donor Advised Fund Deadline
One potentially effective way of reducing taxes is to contribute to charity though the use of a Donor Advised Fund. You can set up such a fund at several financial services firms such as Fidelity and Schwab. However, you need to establish and contribute to the Donor Advised Fund by December 31st, 2019 to be included in your 2019 tax return.
For a refresher on Donor Advised Funds, please access our website and pull up the Summer Notes from this year where there is an extensive description of how a Donor Advised Fund works.
401k Maximum Contribution Raised for 2020
The IRS has announced that the maximum contribution for 401(k) and 403(b) plans will rise by $500 for 2020. The maximum contribution will be $19,500 next year. For those age 50 and up, the catch-up contribution will increase to $6,500 per year. Thus, the total maximum contribution allowed for those 50 years old and up, will rise to $26,000 next year. To continue to make the maximum contribution, please contact your plan administrator to adjust your contribution from your paycheck.
Adding New Talent to Compass Rose
Last month, we filled the vacant position of Client Service Associate. We are pleased to announce that Jim Sambold has joined the staff and he is quickly getting up to speed on the job!
Jim is a graduate of the University of New Hampshire and has studied at Cornell University. Among his many accomplishments, Jim has been a business owner here on the Seacoast and has held several important sales and marketing positions in retail and media. Jim is highly active in the community and participates in multiple volunteer efforts. Please welcome Jim to the team!
Active Versus Passive Investment Management
We note that recent news articles on investment management continue to document the steady inflow of funds to passive index mutual funds or exchange traded funds (ETFs). The increased money flows to passive indexes is partially due to the relative low cost of using index funds. But, the primary driver of index fund popularity is the failure of most active money managers to match or beat the index returns. A recent article by Todd Rosenbluth at CFRA states that only 31% of large cap managers beat the S&P 500 index for the one-year period ending in June 2019. So, almost seven out of ten managers failed in actively trying to beat the index. He also notes that the numbers do not improve if you look back at a longer period.
Given these daunting number, why is Compass Rose continuing to pursue active management of your investments? Well, there are two reasons. First, we are beating the index benchmarks this year. Second, we are beating the index benchmarks longer term as well. So, while it is a challenge to outperform, we believe that active management gives you the best chance to maximize your long-term goals.
However, we do not reject passive investing. Every year, we employ passive indexes in our portfolios to reduce risk and boost returns. We seldom use a broad-based index like the S & P 500 (index of the 500 largest companies in America), but we do use more targeted index funds that we believe have a chance to outperform the S&P 500 or generate income. We tend to focus on sectors of the economy that are doing better than the S&P 500 and invest in an index fund for just that sector. For example, we have frequently used indices for financials, industrials, energy and consumer discretionary sectors. The use of index funds in this way allows us to quickly move in and out of sectors that are simply doing better for a limited period of time.
Just to complete the picture, index funds gives us broad exposure to stronger parts of the economy/markets and we compliment that with individual stocks and some actively managed mutual funds to target investments that we believe will also do better than market in general.
Our goal is to use all the tools to keep you diversified while still pursuing stronger returns. We invite you to discuss our investment process during your annual meeting as we review your investment performance. Please note that you can always review your performance reports in the client portal on our website to see how we do versus the market benchmarks. While we may not always beat the benchmarks all the time, if we do beat the benchmarks over the long term, it will strengthen your life/retirement plan and perhaps allow you to do much more in life than you originally thought.
Our Holiday Wish
With the holidays right around the corner, from all of us at Compass Rose Private Investment Management, we wish you the best of times with your family and loved ones. We are thankful to have you in our lives. Helping you and your family is the passion that keeps us going. And, we are honored by the faith that you have placed with us. Happy Holidays!!