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May 2020 Newsletter

Proving once again that the markets will move in ways which cannot be predicted—at least in the short-term, the equity indices have rebounded somewhat since the end of March.
Of course, the economic news continues to be terrible:  As the economy has been shut down for the past few months, companies are shuttering, some even declaring bankruptcy; joblessness and unemployment figures are beyond what most of us have ever seen. Monthly retail sales were perhaps the worst on record.
Yet the markets seem to be ignoring this data. Investors are all asking why the markets aren’t down more given the economic backdrop. This is similar to March 2009 when investors were asking the same question as the stock markets started their rebound as the economy still was in recession. Money manager Bill Miller had a great quote explaining this. “The market predicts the economy; the economy does not predict the market.” Simply meaning the stock markets will recover well before we know the recession is officially over.
Clearly one reason why the markets have at least temporarily found some support is the Fed. The Federal Reserve and the Federal government have provided a backstop to the financial markets and economy that is unprecedented.  Increased unemployment benefits, the Payroll Protection Program, stimulus checks, open-market asset purchases, relaxation of certain saving/borrowing legislation, etc.  This has added trillions into the economy to help buffer the effects of the work stoppage.
Second, as we said earlier, the market tends to be forward-looking.  That is, it will discount the current news--attempting instead to forecast six to nine to 12 months into the future.  Given the government’s efforts to bring financial stability to the market, there is also optimism—if not very good signs for a breakthrough vaccine/treatment—leading the market to believe that “the other side” will look better than what is currently a terrible situation; eventually companies will rehire, consumers will return, business will ultimately recover and life will look more normal than it does today.
Lastly, it is important to recognize that the market is not a perfect reflection of the economy; instead, it is a collection of thousands of PUBLICLY-TRADED companies—many of which are suffering in the current environment, but also many that are benefiting, if not thriving, during this pandemic. 
In summary, as noted strategist Tony Dwyer put it, “We have an epic battle between Fed support and a very badly hurting economy.” Dwyer’s position is that it is hard to be too negative because of the Fed, but it is also hard to be too positive because of the economic stresses. We think that’s a reasonable stance to take as well. We appreciate research from independent strategists like Dwyer as he has no bias.
Changing Strategy Mid-Game
“Bear markets do not destroy wealth”, says financial advisor Stephan Cassaday, head of Cassaday & Co. “How we behave during bear markets is what destroys wealth.” An excellent and simple quote by Stephan in Barron’s a few weeks ago that we would agree with 100%.
During periods of severe market volatility which is usually marked by extreme investor emotions, typically fear or greed, it is tempting for investors to want to make changes to their investment approach.  When individuals see something is successful, they often want to follow it, irrespective of the validity of the strategy or the history of its success. 
For instance, since the beginning of time, when an actively-managed investment fund (mutual, hedge, etc.) receives a “five-star rating” (generally based on its “PAST PERFORMANCE”), it often portends that a huge inflow of investor money will follow the next year.  Despite the fact that the portfolio manager may be new, the fund’s investment sector was “in favor”, and/or their largest position in the fund had an unusual outsized return performance, investors will flock to it.  The dot-com craze of the late 90’s; how many long-term investors were lured into buying shares of the internet “darlings” of the time that are now defunct?
Time after time in history, the allure of changing strategy especially in the midst of panic selling…or buying, has led investors to make serious mistakes.
Today, there is a debate about exiting index funds and moving into actively-managed funds or even individual stocks.  The argument for doing this is: Why buy the whole market, including all the companies that are struggling, when you can opt for a more specific mix which just includes those that are profiting from this current environment? After all, it’s clear as to who the winners and losers are in this new world, right? If it were only that easy….
In theory, this makes sense. But this is probably more of a sales pitch than good advice for most investors.
When it comes to making a wholesale change to move entirely out of low-cost index funds, it leads to the premise that one will be able to pick the best stocks or fund managers, not only now, but in the future as well. And history has proven that the odds of success of doing this with your whole portfolio are slim. More importantly, we would caution anyone from making such a dramatic shift in strategy during a bear market when emotions usually run high.
There are advantages and disadvantages to owning individual stocks, actively managed mutual funds and index funds (....and all other investments). Understand them fully first before deciding on a strategy.
Complex Investments
We all get “pitched” complex investments from time to time. They sound so great at the outset; they promise returns or safety that you can’t get from a simple index or mutual fund. And generally speaking, most of them get exposed during periods of market stress like now. Again, in general terms, there are some that certainly work out, but here also, the odds are against you.
We’re starting to hear about them now.
Non-traded Real Estate Investment Trusts (Non-traded REITS) are a good example.  They are pitched as safe ways to invest in Real Estate. Until you need your money of course…. Just do a google search about these now and read about how hard it is for investors to get out of these. And quite often, the price at which you are able to sell is nowhere close to the price you see on your statement.
Structured notes are another. Again, another very complicated product that is difficult to get out of when you want your money back. Here also you will find many of these that just collapsed.
Sadly, the WSJ just this past weekend wrote about another complex strategy that seems to be keeping attorneys busy. One large brokerage firm put about $6 billion of client money into a complicated strategy called YES- which stands for “Yield Enhancement Strategy.” Of course, the sexy name sounds attractive- who isn’t looking for more yield??
Without going into too much detail, this particular options strategy is high risk for a few reasons. First, it involves borrowing against the client portfolio-red flag #1. Second, losses could force an investor to pony up more cash or securities-red flag #2. Third, high fees were layered on top of fees the client may have already been paid on the underlying assets-red flag #3, 4, and 5. Again, this is all according to the Wall Street Journal. Somebody please give these clients a list of independent, fee-only, fiduciary advisers in their zip code.
[This unfortunately is another reason why options strategies are given bad names. We are advocates of the covered call option strategy which is nothing like this strategy; although writing covered calls is not meant to entirely eliminate risk (of the underlying holding), it does enhance yield and does reduce risk to a portfolio.  In addition, it is 100% transparent with its upside and downside clearly defined.]
We believe most investors do not need complex investments. We feel a portfolio of index funds, active mutual funds, and/or individual securities (along with the aforementioned covered call strategy) will serve investors best over time. All publicly traded with transparent fees and easy to understand risks.
One area that we continue to emphasize is dividend-paying stocks.  While many individual companies have been punished in the recent sell-off, companies that pay investors to hold their stocks offer a significant benefit.  Receiving dividends while waiting for the markets to recover is much more desirable than going to 100% cash and guaranteeing losses by just spending your cash earning zero (assuming you are in retirement and need the income).
It is true that in this environment, many companies are protecting their cash in order to stay in operation—or just to anticipate what the future will bring.  In many cases, this is good stewardship.  However, in some instances, there are exceptional companies that are actually raising their dividends, displaying their strong position and optimism of the future.  Johnson and Johnson (JNJ), for example, has much-need products and has been working on a vaccine/treatment for Coronavirus; with a very strong balance sheet, the company recently announced an increase to their dividend.  Proctor and Gamble (PG) has benefited tremendously from consumers stocking up on its products and also is in a very strong financial position; they raised their payout.  Starbucks (SBUX), now re-opening stores in China as well as making good use of their drive-thru locations, is also in a position to hike their dividend.
Dividends not only represent some comfort to lower stock prices in times of down markets, but these payouts also provide a valuable stream of funds that can be reinvested or withdrawn and used as income for investors.
Market Predictions
There is no shortage of market predictions today. When a public person (i.e., anyone with an audience) makes a prediction, it’s always prudent to learn where his/her interests lie when deciding if that prediction should be taken seriously.  The most important thing for us all to understand is that nobody knows for sure what is going to happen in the markets. These are incredibly uncertain times for sure. Be very skeptical though of market predictions. Think of the source of the prediction. For example, hedge funds or hedge fund like strategies can play a role in a diversified portfolio, but how many times have you ever heard a hedge fund manager be positive on the markets? Not often. Many other market pundits (who don’t even make real life decisions for clients) make wild predictions. Our advice is to pay very little attention to these wild market predictions and to focus more on the things we can control.
As we said earlier, a balanced approach makes most sense to us. We do not force clients into one size fits all models. The most prudent approach is to stick with your investment strategy, but it’s ok to deviate from it somewhat when/if needed. IT ALL DEPENDS ON THE INDIVIDUAL’s UNIQUE CLIENT SITUATION. As we have always said, it is ok to hold some excess cash from time to time. Most in the industry think that is taboo, but we suspect that’s more because holding excess cash on a personalized and customized basis doesn’t fit into a scalable one size fits all model. We are very cognizant of how much the Federal Reserve has supported the markets. Most likely, equity prices would be far lower than they are without this tremendous support.
Instead of wasting time thinking about whose market predictions will come true (and some inevitably will….but good luck picking which one AND it is almost certain whoever gets this major market "call" right will get the next one wrong), do the following:
Revisit your asset allocation and strategy-does it still reflect your goals, needs, and risk tolerance?
Do you have enough cash set aside? Enough access to an emergency fund?
Should you consider a ROTH IRA conversion?
Should you tax loss harvest?
Should you rebalance your portfolio?
Should you refinance or pay off debt?
And there are plenty of other more worthy things to do with your time than pay attention to these market pundits just looking to make a name for themselves. 
Stay safe and all the best,