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July 2019 Newsletter

Conditions for the financial markets continue to be relatively positive:  unemployment levels remain low; retail sales have been strong and low interest rates persist.  Earnings season is starting, however, and results have been somewhat mixed. Ultimately, one would expect that company numbers and their future outlooks will dictate the health of the markets as we move into the second half of the year.  One would expect….
As has been the predictable story for quite some time, the actions of the Federal Reserve dominate the scene when it comes to investor anticipation about interest rates.  Despite the stronger recent data, Fed Chairman Powell has been adamant that “economic uncertainty” remains and that future interest rate cuts are likely.  As such, a market hungry for low rates is now not only expecting at least ONE cut at the next Fed meeting later this month, but, of course, hoping for TWO!  How much of this (…and/or whether it will be one or two rate cuts) is already priced into the market is TBD, but the markets want lower rates without question.
Certainly, it can be argued that Powell is not simply capitulating to the markets; globally, economic conditions are at best stagnant, at worst, declining.  In foreign markets, yields on sovereign bonds are negative.  In fact, Europe is not only seeing negative interest rates on high-grade companies, but is now seeing JUNK bonds with negative yields. 
Is Active Management Becoming Harder, Not Easier?
The trend toward index investing has accelerated over the last 10 years and actually seems to even be getting stronger. According to Morningstar, passive funds’ share of the market has doubled in the last 10 years. In US equities alone, Morningstar states that passive funds are now equal with active funds at about $4.3 trillion each.  That is amazing growth! With this mass exodus to passive investing, some might believe that those active managers who have been able to endure would now have an advantage to outperform. The argument from the actively managed fund industry is that as more and more money is “indexed”, the market becomes less efficient, allowing skilled managers to exploit those inefficiencies.
However, recent studies have actually shown the opposite:  Looking at the data, according to a study done by Larry Swedroe, Director of Research at Buckingham Asset Management, the failure rate of active fund managers has steadily increased over the years at the same time index investing has exploded. This appears to fly in the face of logic; it would seem that with fewer active managers, there would be less competition and it would be easier for the surviving managers to outperform.  Instead, the studies show that those trying to “beat” the averages continue to fall short due to two primary reasons:
First, active investing is a zero-sum game; one wins at the expense of another.  As more active players have a poor experience in trying to beat the market and fall out of the “game,” the opportunity to exploit their mistakes also declines. 
And second, somewhat similarly, as more of the “lesser” players drop off, thus leaving the more skilled active managers, the competition among the existing managers gets tougher and tougher.  As such, it is harder and harder to find an edge for the active managers.
While successful investing will always require the right allocation across asset classes, investors are realizing that active management has just not been as effective as in the past.  And passive investing may be more appealing….at least until we hit the next prolonged bear market.
Insurance in Retirement
For most people, insurance is a necessary part of their financial planning, especially in their younger years when they are protecting a mortgage and, possibly, looking to secure financial support for their children who are minors.  As time goes by, however, and most of the factors that led them to purchasing the insurance in the first place are no longer priorities, the idea of keeping it might not seem to make sense.
In some cases this is true, but in others it might be useful to keep the insurance.  Here are five examples of the advantages of keeping insurance in retirement:
  1. Transferring wealth to heirs.  Life insurance benefits are income-tax-free and provide an effective way for families to equalize estates among their children.
  2. Access to cash.  If there is value in a life insurance policy and the same level of coverage is no longer needed, the cash can be used to supplement retirement income.
  3. Support for a widow/widower.  Having a policy that is in force to pay for a surviving spouse and ensure a quality of life to them can be reassuring.
  4. Protection from the onset of chronic illness.  Certain life insurance policies will allow the owner to access the benefits in the event of a chronic illness before death. 
  5. Charitable Giving.  Insurance policies can be gifted to charities; the beneficiary could be changed to the charity.  This would allow the owner to continue his/her charitable giving while still providing a reasonable inheritance to heirs.
Maintaining insurance into and through retirement may be expensive, and it may not be feasible or appropriate for every case.  However, obtaining insurance once it is dropped--due to age and possible health issues, will inevitably be more difficult, if even possible. 
At NCM, we routinely help clients with these decisions. What types of insurance a client should have, what amounts, and how insurance fits into their overall financial plan are all areas where we can provide advice.
The Endless “Issue” of Debt
Debt comes in all forms.  Individuals carry debt, corporations issue debt and countries often pay for their expenditures through debt.  In general, debt is considered a negative, but in reality, debt largely fuels the economy. 
Many are wondering why the US Fed is on the verge of cutting interest rates for the first time in nearly a decade.  However, when we look at the data, the answer may become clearer as the “cost” of the debt is largely based on prevailing interest rates.  Here are some recent statistics from the Federal Reserve: 
  1. Mortgage debt in 2019 is higher than it was in the peak of the bubble in 2008;
  2. Credit card debt is 50% higher;
  3. Student debt has doubled;
  4. Corporate debt has more than doubled;
  5. Car loans are 50% higher.
Perhaps most surprisingly, credit card defaults and delinquencies are back to levels not seen since the financial crisis.  Last quarter, banks wrote off $8.8 billion credit card debt which is the largest amount since 2011.  And despite the fact that the US is in the midst of the longest economic expansion on record, the US government debt has more than doubled since 2008, from 9.5 trillion to $22 trillion today.
And of course, this means that government bonds—as well as corporate and junk bonds—are being issued in record amounts.  But investors are gobbling them up.  Bond-based exchange-traded funds (ETF’s) are seeing dramatic inflows, nearly setting records for the first half of 2019, taking in $72 billion in new assets.  Overall, taxable and government bonds inflows are up 11.5% in 2019, with municipals up 9%.
Meanwhile, equity ETF’s have only seen a rise of 3% of new money for the first half of 2019.  These results largely reflect the nervousness investors have, but also highlight the dependence that investors have in the Fed and the reliance on loose monetary policy. 
Lower rates will benefit bond prices—and have certainly helped stock prices, but as we can see, lower rates have also become a very important component to the overall US economy. If rates ever do rise again, think about how much the cost to service all of this debt will rise….
All the best,