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January 2020 Newsletter

As we head into 2020, the market is dealing with the familiar issues it faces every new year:  company earnings, economic growth prospects and, naturally, overall valuations.  These days, however, we can add in geo-political headlines, a pending impeachment trial and an upcoming U.S. presidential election later in the year.  And, of course, markets always have to consider the Fed and the direction of interest rates----perhaps arguably THE most important driver of investor influence over the past few years.

Yet despite the growing list of issues which confront investors daily, the markets remain surprisingly resilient. Reports of weaker than expected economic data? No problem. House impeachment of the President? Yawn. Tensions rising with Iran? Equities touch new highs. Constant predictions from market pundits of a coming recession and significant stock market correction? Not true…at least not yet.

What is also quite surprising is that looking at reported fund flows, it seems that the average individual investor is not nearly as involved as in previous bull markets. It was only about one month ago when the WSJ wrote an article titled “Individual Investors Bail on Stocks”. As of late 2019, investors had pulled $135 billion from US stock-based mutual funds and ETF’s---the biggest withdrawals on record according to Refinitiv Lipper, which tracked the data going back to 1992.

Instead, investors have shifted hundreds of billions of dollars into bonds and money market funds. All of this could be viewed as a positive for the stock market as perhaps there is still a lot of pent up demand for stocks as yields on cash and bonds remain quite low.

One area to take note of, however, is the increasing effect a small concentration of stocks is having on the market averages.  According to a Morgan Stanley report, “Apple, Microsoft, Alphabet, Amazon and Facebook now make up 18% of the total market cap of the S&P 500.”  In short:
  • For every $100 invested in the S&P 500, nearly $10 goes straight to just Apple and Microsoft.  And if you include Amazon, Google and Facebook, this share rises to close to $18.  So, to put it in context, if the S&P 500 were equally weighted, for every $100 invested in the S&P 500, each company would receive only $.20 cents.  Instead, five companies command nearly 20% of every dollar, while the other 495 companies split the balance (80%)! 
Not surprisingly, in their note, Morgan Stanley goes on to say, “A ratio like this is unprecedented, including during the tech bubble.”

Undoubtedly, in nearly every bull market, certain large companies will emerge to have an outsize impact on the averages.  However, in many of these instances, such unequal weightings among a small number of stocks which account for most of the gains is not sustainable; either those stocks--which are “carrying” the market--will pull back….or the rest of the market will need to catch up.  Last year, for instance, Apple and Microsoft alone accounted for 15% of the S&P 500’s advance in 2019.  And in another example—which gives further perspective--here is one more rather remarkable statistic:
  • When it comes to the tech-heavy Nasdaq 100 (symbol: QQQ), the weighting concentration is even more pronounced:  Apple, Microsoft and Amazon receive over $.30 of every $1 invested in this index.  Add in Facebook and Google and these five stocks take in nearly $.45 of $1….Almost 50% of the index is weighted among only five stocks. 
How long the market will continue to ride this wave remains to be seen.  Most likely, we will get a much better sense of the year as corporate earnings begin to hit in the next few weeks. Of course, year-end results of the past year will be less important than the forward guidance companies provide for the balance of the year.

Big Changes from the Secure Act

A new law was recently passed which most likely will significantly affect many retirement savers.  Here are a number of the basic points of this new legislation:
  1. One of the big changes is the increase in the age from 70 ½ to 72 at which individuals are required to withdraw funds from IRA’s or 401k’s.  There continues to be no required minimum distributions (RMD) from a Roth IRA established in your name.
  2. Another change is the elimination of the age restriction for making contributions.  Previously, in a traditional IRA, individuals could no longer make contributions in the year they turned 70 ½; beginning in 2020, there is no age restriction---as long as the individuals report “compensation.” Roth IRA’s have never had an age mandate for contributions, and the new law does not change this.  (Note:Contributions to IRA’s after age 70 ½ (now allowed under the new law) may reduce the amount of IRA qualified charitable contributions (QCD)--which are allowed to be made from an IRA after age 70 ½.)
  3. Perhaps the most controversial change comes from the elimination of the “stretch IRA.”  Under previous law, non-spousal inherited IRA’s could be distributed over the life of the inheritor.  Under the new Secure Act, all assets of an inherited IRA (traditional or Roth) must be withdrawn within 10 years.  Individuals are not required to take a distribution within the 10-year period; however, the entire amount must be withdrawn by the 10th year.   This change does not affect A) surviving spouses, B) a minor child of the deceased account owner, C) a beneficiary who is no more than 10 years younger than the deceased account owner or D) a chronically-ill individual.
  4. Another change should increase the availability of annuities in retirement plans, as the responsibility of vetting the appropriateness/suitability of the products under the new law shifts from the employer to the insurance companies—or those selling the products.
  5. Lastly, individuals will be allowed up to $5,000 to be distributed penalty-free from an IRA for the birth or adoption of a child.
  6. Student Loan Repayment through 529 Savings Plans: Individuals can withdraw up to $10,000 from 529 plans to make student loan payments.
From our perspective, the elimination of the stretch IRA is the one change that grabs our attention the most in terms of long-term financial planning and determining whether strategies such as ROTH IRA conversions still make sense or perhaps should be accelerated. Another area that is important to review is beneficiary designations as the new law could impact long-term planning of beneficiary strategies.

And, of course, the last important takeaway from this new legislation is that every individual situation continues to be unique; it is paramount that investors receive personalized retirement/tax advice to fit their own situation.  And although much of Wall Street is shifting towards the "commoditization" of services, customized guidance just cannot be scaled.

Same Strategy, Different Market

For years, Jeffrey Vinik was a tremendously successful portfolio manager (both at Fidelity Investments and as a hedge fund manager). His strategy revolved largely around his stock-picking prowess, and he was able to generate superior returns to investors over the years. After shuttering his last investment fund in 2013, Mr. Vinik started a new venture in early 2019, hoping to raise $3 billion in assets under management (AUM). Citing both his inability to attract a sufficient amount of capital, as well as increased competition, however, Mr. Vinik decided to close this hedge fund less than eight months after starting it.

The noteworthiness of this story does not end in Mr. Vinik’s failure to meet his own goal of raising enough capital for the “economics to make sense” (his words.) Nor is it in his performance---which was rather lackluster.

Instead, this tale highlights the general theme of how much the market has changed over the years from a period where active management was not only sought after, it was lavishly rewarded. Today, a top-rated, distinguished money manager was not able to raise funds, despite being in an era that is seemingly awash with investor money. It is clear to us that this reflects investors' strong aversion to active management (...in some cases despite good performance) and their seemingly endless appetite for passive investments (e.g., index funds) at any cost---no pun intended. And as further evidence, this is the fifth straight year that more hedge funds have closed than have opened.

Today, there are no star mutual fund managers anymore. Instead, the three most important players on Wall Street these days may be Vanguard, BlackRock, and State Street as increasingly more of every dollar invested in the stock market ends up in one of these companies’ sponsored ETF’s.

Perhaps fundamental stock-picking will have its day back in the sun; but for now, passive strategies are the favored investment style.

All the best,