Things are not as bad as the media would have you believe

Queen Elizabeth II turned ninety years old on April 21st.  While I don’t follow the Royal Family all that closely, I do love Princess Kate’s fashion sense and have a thing for sparkly tiara’s (the real ones).  So naturally when I saw an article about the Queen’s birthday I had to check it out.  In addition to some great shots of the Crown Jewels, I found one of the Queen’s comments particularly uplifting.  When asked about the state of the world, Elizabeth unequivocally said that things are much better today than when she was a child.  Although recent headlines – from terrorist attacks to slowing global growth – would have us believe otherwise, I’d like to provide some much-needed evidence that we’re living in pretty good times.

First, Americans are living longer and are healthier than ever before in history.  In 1800 the U.S. life expectancy was 39 years at birth, then 49 years in 1900, 68 years in 1950, and an incredible 79 years today!  In addition to a longer life expectancy, we can take advantage of our twilight years with something called retirement.  The concept didn’t exist in the U.S. prior to the late 1880’s, when workers pretty much labored until they died.  That started to change in 1875 when American Express offered America’s first employer-provided retirement plan.  The Federal Government followed suite in 1935 with the creation of Social Security; and medical health benefits for those over 65 years, also known as Medicare, started in 1965.

According to the Federal Reserve, the number of years spent in leisure – measured as retirement plus time off during your working years – rose from 11 years in 1870 to 35 years by 1990.  While we’re not all experiencing a Downton Abbey lifestyle, things could be worse.

Concerning crime and violence: while the tragic terrorist attacks in recent years are difficult to reconcile, overall murder rates in the U.S. have dropped dramatically since the 1990’s.  America averaged 20,919 murders during that decade but the average number of murders in the 2000’s dropped to 16,211.  On a global level, a report from the Human Security Report Project suggests the world is getting safer, as it relates to people killing other people.  Deaths from war has been in decline since the end of World War II and high-intensity conflicts have declined by more than half since the end of the Cold War.  The report goes on to say that terrorism, genocide, and homicide numbers are also down.

Americans often worry that slowing U.S. growth and rising debt levels will result in a downward economic spiral.  They often point to Japan as a worst-case-scenario.  While the island nation has its challenges, consider that Japanese unemployment has remained below 5.7% for the last 25 years, income per capita adjusted for purchasing power continues to grow at a healthy rate, and life expectancy is on the rise.  Plus I hear they have amazing sushi.  I can think of worse outcomes.

Another common concern I read about is stagnant wage growth.  While I believe this is an important issue, consider that the median annual household income adjusted for inflation was about $25,000 in the 1950’s.  Today it’s almost double that!

A few other things that are better: U.S. death rate from strokes has declined by 75% since the 1960s; deaths from heart attacks have also dropped dramatically; more Americans attend college today than at any other time in our history; smoking is down sharply; poverty is on the decline in the U.S.; and fewer people around the world die from famine each year.

Happily, I could go on, but I won’t.  Suffice it to say that Queen Elizabeth II, in her 90 years of experience and wisdom, may be right.  And even if she’s not, we’re all better off believing she is.

Carrie A. Tallman, CFA
Director of Research

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What is Smart Beta?

You’ve undoubtedly heard this term, used to describe a certain type of investment that is becoming increasingly popular. What does it mean? And if these investments are “smart,” does that mean that the others are “dumb?”

So-called “smart beta” investing is a bit of an active/passive hybrid methodology. Traditional passive investments are typically replicas of well-known market capitalization-weighted indices, like the S&P 500. A market cap-weighted ETF holds each company in the index according to its size in the index, which can be calculated by multiplying a company’s outstanding shares by the current market price of one share. While this provides broad market diversification at a very low cost, one drawback of this approach is that the companies whose stock prices are rising become relatively larger while companies whose stock prices are falling become relatively smaller. If markets are less than perfectly efficient and stock prices are anything other than fairly valued, cap-weighted indices will tend to favor overvalued companies.

“Smart beta” strategies use different weighting schemes to construct a portfolio, involving metrics such as dividends or low volatility, or even equal-weighting, all of which sever the link between price and weight and tend to provide a value tilt to the portfolio. The reason for this is that, when rebalancing the portfolio, these strategies result in buying low and selling high. Portfolios based on market cap-weighted indices will often do the opposite when rebalancing, buying more shares of the companies whose stock prices are going up, and vice-versa. According to Research Affiliates, LLC, “smart beta” strategies must also encompass the best attributes of passive investing, such as transparency, rules-based methodology, low costs, liquidity, and diversification.

Does this mean that “smart beta” is a panacea that will bridge the gap between active and passive investing? Many of these strategies have back-tested well and have become increasingly popular, resulting in large inflows of capital. Rob Arnott, one of the pioneers of smart beta at Research Affiliates, has written about rising valuations in smart beta investments as a result of their soaring popularity (“How Can “Smart Beta” Go Horribly Wrong?”). He cautions against “being duped by historical returns” and advises investors to adjust their expectations for future returns to account for mean reversion. He and his co-authors think there is a possibility of a smart beta bubble in the works, due to the rising popularity of such strategies.

And what about traditional passive investments? Is there still room for these vehicles in an investor’s portfolio? Absolutely, particularly in the more efficient sectors of the broad market.  Even Arnott believes “there is nothing “dumb” about cap-weighted indexing.” At Parsec, we stay abreast of current investment trends, but use a measured approach to portfolio construction that is research-based and backed by sound financial theory. We don’t believe any one investment is particularly “smart” or “dumb,” but rather that there is room for different types of investments within the context of a well-diversified, well-constructed portfolio.

Sarah DerGarabedian, CFA
Director of Portfolio Management

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Brexit: What is it and what are the investment implications?

There have been many headlines recently about the so-called “Brexit”, or the possibility of the United Kingdom leaving the European Union. There is a referendum on the subject coming up on June 23 in the UK, with current polls showing 47% in favor of staying and 40% in favor of leaving. This is not to be confused with the “Grexit” fears from a few years ago about the possibility of Greece leaving the European Union as well as the Euro currency. The UK is different in that it is a member of the EU, but continues to use the Pound as its currency rather than the Euro. Therefore, the UK maintains its own central bank and monetary policy. The main effect of such an exit has to do with trade agreements within the EU.

Potential negatives of an exit include a possible slowdown in the UK economy, short-term local stock market volatility and\or depreciation in the Pound. The EU represents about 50% of UK exports but only about 10% of imports, so if trade agreements are less favorable as a result of the exit then the UK stands to lose.

There are also positive factors to consider with regard to the UK. According to Goldman Sachs, the economy (as measured by Gross Domestic Product) in the UK is projected to grow faster than that of the US or the other Euro area countries in both 2016 and 2017. The Pound has already fallen 9% against the dollar over the past year, and the UK stock market has underperformed both the S&P 500 and the MSCI EAFE index over the same period. A vote to remain in the EU would remove the current uncertainty, and could be a catalyst for UK stocks to reverse their recent underperformance. If the vote is to leave the EU, many trade agreements will need to be renegotiated. This process will likely take years to complete, while UK stock market volatility should be short-lived.

To quantify our clients’ potential exposure to the UK, in a typical portfolio our target weighting for international stocks is about 26% of the overall allocation to equities. Of this amount, approximately 1/3 is emerging markets and about 2/3 developed markets. The UK is considered a developed market, and makes up about 20% of the MSCI EAFE index, which is the primary benchmark for most actively managed developed international mutual funds. This would imply that roughly 3-4% of our typical stock portfolio has exposure to UK equities through mutual funds, plus any additional exposure through individual stocks we might buy that are headquartered in the UK.

Since the outcome of the Brexit vote is impossible to predict with certainty, portfolio exposure to UK stocks is low and the effect of the vote on stock prices is indeterminate, we are maintaining our current target weights in international stocks.

From a diversification standpoint, investing in international stocks reduces overall portfolio risk since foreign stocks do not move exactly in tandem with US stocks. Sometimes international investing improves portfolio returns and sometimes it does not. In recent years international stocks have underperformed relative to the US, but historically there have also been periods of significant outperformance. While there will be more hype and headlines as the June 23 vote approaches, we remain committed to long-term investing in a globally diversified portfolio.

William S. Hansen, CFA
President
Chief Investment Officer

Bill

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IRA Beneficiaries: Per Stirpes vs. Per Capita

Did you know that your IRA beneficiary supersedes your will? No matter how carefully you’ve crafted your last intentions in your will, an outdated IRA beneficiary that was never updated after your divorce can unwittingly bestow your former spouse with all of your IRA inheritance, while also disinheriting your new spouse and children. That’s why it’s important to update your beneficiaries after major life changes such as marriage, divorce, births, illness, domestic issues and deaths.

While you’re at it, make sure to check how the beneficiary form reads too.  Most will default to either a “per stirpes” designation or a “per capita” designation. Knowing the difference in these two designations is important, as is making sure you understand what the form you’re signing defaults to, so you can override it if necessary.

Both of these designations refer to what happens if one of your beneficiaries is no longer living.  A per stirpes designation means that if one of your IRA beneficiaries is deceased, the deceased person’s children will receive his or her share.  Imagine you have two children – a son and a daughter – to whom you’ve split your IRA beneficiaries 50/50.  Your daughter has two daughters and your son has two sons.  At your death, if your son has not survived you, your two grandsons would receive his share of the IRA.  Your daughter would receive 50% of the IRA and your grandsons would each receive 25%. Keep in mind that if your son had no heirs, the entire balance would go to your daughter.

A per capita designation does not look along the lineal lines. Instead, if one of your beneficiaries is deceased, the proceeds are distributed to the other beneficiaries as if the deceased beneficiary was not to inherit any, regardless of whether or not he/she had children. Imagine you have three children, and each is to receive a third of your IRA.  If one child predeceases you, the IRA would go equally to the living two children.

What if none of your primary beneficiaries survive you (and either you selected per stirpes but your beneficiaries have no children, or you selected per capita)?  That’s when the contingent beneficiaries become important.  Your IRA money will go to your contingent beneficiaries only if no primary beneficiaries survive you. If you want to ensure that one of your heirs receives a portion of the IRA, you must name him/her as a primary beneficiary.

Why can’t you just avoid this whole beneficiary form and let the will name your beneficiaries?  You can, but your estate is not considered a person under the law, and therefore beneficiaries will have limitations to how long they can stretch out distributions from the IRA.  They will not be allowed to stretch the distributions out over their lifetimes, which will result in losing valuable tax-deferred growth. Review your beneficiaries with your financial advisor to ensure the are aligned with your intentions.

Harli Palme, CFA, CFP®
Chief Operating Officer
Chief Compliance Officer

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Hidden Costs of College

Congratulations!  You have four years of tuition, room and board stashed away in your 529 Plan and Junior hasn’t even graduated from high school yet.  Now you can breathe easily, right?  Well…maybe, maybe not.

The published cost of college attendance can vary substantially from the actual cost for numerous reasons.   The primary contributor to this variance; a surprisingly small number of students graduate in four years.   In fact only 59% of students graduate within six years according to the National Center for Education Statistics.       Now before you blame Junior for taking too long to get that degree (and blowing your budget), understand that getting the classes needed to fulfill degree requirements at a large university can be a daunting, if not impossible, Hunger Games-like experience resulting in an extended stay.   Changing majors, transferring schools and required remedial classes are other common contributors to a longer than expected the graduation time line.

One cost-effective way to manage the timeline is to plan on taking required classes you couldn’t get during the regular school year at your local community college during the summer.   Budget for this (hopefully minimal) additional expense and have the classes pre-approved so your student receives credit for their work.  Also, insist that your student meet with their advisor before scheduling classes to confirm they are on the right path to meeting their degree requirements.  Now that you are on the four-year plan, it’s time to understand some of the other hidden costs of college.

While wandering the park-like grounds and admiring the architecture of the colleges on your tour list, it can be easy to forget a very important question.  Is this a comprehensive fee?  Quite often the answer is yes at a private college and hard to ascertain at a public school.   To help compare apples and oranges, take a checklist of possible extra fees or expenses on your tour so you ask the same questions everywhere.

  • Are there class-specific fees? For example, lab fees for science classes or studio fees for art or music classes.
  • Are there differential fees for specific majors?
  • Does the school charge more for additional credit hours? Some schools have a  50% tuition surcharge for credits in excess of degree requirements.
  • Is tutoring an additional expense? Is the tutoring remedial only?
  • Are there use fees for athletic facilities, the health center, and tech support?
  • Is there a fee for printing?
  • Can you rent textbooks at the campus bookstore?
  • What percentage of the student body lives on-campus vs. off-campus? If your student lives off-campus budget for rent, security deposit, utilities, furniture, and renters insurance.
  • How far is the school from your home? You may need to budget for travel expenses and summer storage fees.
  • What does it cost to have a car on-campus?
  • Do you receive college credit for study abroad programs?
  • What extracurricular activities interest your student? Greek organizations and club sports teams can cost thousands of extra dollars each year.
  • What is the process to get student tickets to football or basketball games and what do they cost?
  • What are some of the other small fees you can expect? Many schools charge an orientation fee, a matriculation fee, and a commencement/graduation fee.
  • And last but not least… expect a 3% fee for paying the other fees with your credit card.

Once you have narrowed down your list of potential colleges, find someone who has a student there and ask about the hidden extras.   You may be surprised to find that the private school, with a high four-year graduation rate, and a comprehensive fee compares more favorably than you expected to a large, public university.

Nancy Blackman
Portfolio Manager

Nancy Blackman - Parsec Financial Corporate Headshots

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Market Update Through 03/31/2016

as of March 31, 2016
Total Return
Index 12 months YTD QTD March
Stocks
Russell 3000 -0.34% 0.97% 0.97% 7.04%
S&P 500 1.78% 1.35% 1.35% 6.78%
DJ Industrial Average 2.08% 2.20% 2.20% 7.22%
Nasdaq Composite 0.55% -2.43% -2.43% 6.94%
Russell 2000 -9.76% -1.52% -1.52% 7.98%
MSCI EAFE Index -8.27% -3.01% -3.01% 6.51%
MSCI Emerging Markets -12.03% 5.71% 5.71% 13.23%
Bonds
Barclays US Aggregate 1.96% 3.03% 3.03% 0.92%
Barclays Intermediate US Gov/Credit 2.17% 2.58% 2.58% 0.75%
Barclays Municipal 4.38% 1.84% 1.84% 0.35%
Current Prior QTR
Commodity/Currency Level Level
Crude Oil  $38.34  $37.04
Natural Gas  $1.96  $2.34
Gold  $1,235.60  $1,060.20
Euro  $1.13  $1.08
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My Introduction to the New York Stock Exchange

Wendy Beaver is a financial advisor in our Southern Pines office.  She got her start on Wall Street and we wanted to know what her experience was on the NYSE.  Here is what she had to say:

As a former Head Equity Trader of NationsBank and a former Manager of Business Development of Prime Executions, a firm on the Floor of the New York Stock Exchange, I spent many years closely involved with the workings of the NYSE. It all started in the early 1980s, when I was a junior equity trader at InterFirst Bank in Dallas, Texas. For many years, The New York Stock Exchange held a program to introduce up and coming people in equity trading to the NYSE, called the FACTS Program. An invitation to attend this day long program was coveted among my peers. When I received my invitation, I was honored, and, I must admit, a little nervous at the thought of spending a whole day at the venerable New York Stock Exchange.

As it turned out, that day began a life long love and respect for the New York Stock Exchange, whose history began with the signing of the Buttonwood Agreement by 24 New York City stockbrokers and merchants on May 17, 1792, outside at 68 Wall Street under a Buttonwood tree. Twenty-five years later, on March 8, 1817, the organization officially became the New York Stock Exchange Board, later simplified to the New York Stock Exchange. The location changed several times over the years before settling into its present locational 11 Wall Street in 1865. The Neo-Classical building was registered as a Historic Landmark in 1978.

A few years after this important registration, I was there attending the FACTS Program. The day started with an introductory meeting outlining the days events, after which my fellow attendees from throughout the country and I were taken to the NYSE Trading Floor. My first stop was at the post of a Specialist firm. The Specialist was a member of the NYSE, whose role was to maintain a fair and orderly market in his inventory of stocks listed on the New York Stock Exchange. They had actual long and narrow books with lined pages where the existing buy and sell interest was written at particular prices. If there were no actual client interest, the Specialist firm had to use their own capital to facilitate the trade. It was fascinating to me to observe as the Floor Brokers approached the Specialist post, checked the book up and down and began negotiating their order.

The next stop was to be assigned to a Floor Broker, who could be employed by a member firm of the  NYSE (Merrill Lynch, Paine Webber, etc.), or be an independent $2 Broker representing many member firms. Their role was to execute the orders from the clients of those firms. The Floor Broker picked up the order from his clerk in his firm’s booth around the perimeter of the Trading Floor. Buy orders were written on green tickets and sell orders were written on pink tickets. Then the Floor Broker walked very quickly(running was prohibited) to the Specialist post where that stock was traded. After negotiating with the Specialist and executing the order, the Floor Broker tore the ticket off the pad and threw it on the floor. At the end of the day, paper tickets were knee deep on the Trading Floor! The Floor of the New York Stock Exchange was the busiest and most exciting place I had ever been. Through human communication and interaction, a large majority of the equity trades that took place in this country were executed there.

The rest of the day was spent with lunch in the Stock Exchange Luncheon Club, a wood-paneled dining room that served members of the NYSE and other Wall Street professionals from 1898 until it closed in 2006, and a visit to the Boardroom of the NYSE, which held a rostrum from the original floor from the early 1800’s and the urn given as a gift to the New York Stock Exchange by Czar Nicholas II of Russia in 1904. ( I was fortunate enough to return to the Boardroom quarterly from 1994 to 1997, when I was asked to be a member of the Institutional Traders Advisory Committee to the Board of the New York Stock Exchange.) A closing reception was held for us in the Luncheon Club at the end of the day.

The bull markets of the 1980s and 1990s shattered all trading records. In fact, volume topped 2 billion shares a day in 2001. Although the NYSE upgraded its technology constantly over the years to meet the increasing volume, this amount of volume presaged changes to come. In 2005, the New York Stock Exchange merged with Archipelago, the first all-electronic exchange in the United States. In 2006 the NYSE ArcaEx merger created NYSE Arca and formed the publicly owned and traded for profit NYSE Group, Inc. In turn, NYSE Group merged with Euronext, creating the first trans Atlantic stock exchange group. In 2008, Specialist firms became Designated Market Makers. Finally, on December 20, 2012, Intercontinental Exchange, an American Futures Exchange, bought NYSE Euronext.

In October 2014, my Parsec colleague Greg James and I visited the NYSE Floor. It is a much quieter place now, with Floor Brokers working from trading desks with Designated Market Makers, often using hand held computers. Today more than half of all NYSE trades are conducted electronically, and Floor Traders are used to set prices and deal in high volume institutional trading. It is considered the largest equities-based exchange in the world based on total market capitalization of its listed securities. That being said, I still got that same awe-inspiring feeling walking onto the Trading Floor with Greg that I got many years ago walking onto the Trading Floor as a junior trader at the New York Stock Exchange for the first time.

Wendy S. Beaver, AAMS®
Financial Advisor

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32nd Annual Economic Crystal Ball Seminar

Each year we co-sponsor the Annual Economic Crystal Ball with UNC Asheville.  This is a great opportunity to hear Parsec’s Chief Economist, Dr. James F. Smith, and Nationwide’s VP and Chief Economist, Dr. David W. Berson, discuss the economic and financial outlook through 2017.  To register please email Kimberly Moore at kmoore@unca.edu or call at 828-251-6550.   A copy of the brochure can be found here.

  • Location: Lipinsky Hall Auditorium (Next to Ramsey Library)                                               UNC Asheville Campus
  • Date: Thursday, April 28, 2016
  • Reception: 6:15 p.m.
  • Economic Outlook:  7:00 p.m.
  • Financial Outlook: 7:30 p.m.
  • Q & A: 8:00 p.m.

The Economic Outlook will focus on inflation, employment, interest rates, the strength of the dollar and the housing market. The Financial Outlook will explore the implications of Federal Reserve policy for the financial markets. Various investments will be addressed, with an emphasis on interest rates and the bond market.

About our Speakers

David W. Berson, Ph.D                                                                                                              Dr. Berson is Senior Vice President and Chief Economist at Nationwide Insurance, where his responsibilities involve leading a team of economist that act as internal consultants to the company’s business units.  His numerous professional experiences include Vice President and Chief Economist at Fannie Mae from 1989-2007, past president of the National Association of Business Economists, and senior management position with Wharton Econometrics Forecasting.

James F. Smith, Ph.D.                                                                                                              Dr. Smith is the chief economist at Parsec Financial.  He has more than 30 years of experience as an economic forecaster. Dr. Smith’s career spans private industry, government and academic institutions, and includes tenures with Wharton Econometrics, Union Carbide, the Federal Reserve and the President’s Council of Economic Advisers.

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The Year of The Fiduciary Rule

For about a year now, the industry has witnessed much conjecture and debate about the proposed Department of Labor’s Conflict of Interest rule, also known as the “Fiduciary Rule.”  The rule attempts to broadly categorize anyone offering investment advice to retirement plans or IRAs as a fiduciary.  It is in the final stages of review with the Office of Management and Budget and is expected to pass.

The mechanics of how this works are seemingly straightforward.  An advisor recommending a rollover of retirement assets into an IRA or similar account would be considered a fiduciary.  That matters because a fiduciary cannot make a recommendation that would cause his or her income to increase.  The rule indicates a five-prong test to determine if a person is advising retirement assets.  If any of the following apply, you are now considered a fiduciary:

  1. If you advise on the purchase or sale of securities or property in a retirement account;
  2. advise taking a distribution from a plan or IRA;
  3. manage securities or property including rollovers from a plan or IRA
  4. appraise or offer a fairness opinion of the value of securities or property if connected with a specific transaction by a plan or IRA; or
  5. recommend a person who is going to provide investment advice for a fee or other compensation.

Retirement plan sponsors should take note because if you read the rules correctly, it suggests anyone (including laymen) offering advice to a plan participant or an owner of an IRA would likely be considered a fiduciary and could be held personally liable for their recommendations or advice.

Registered Investment Advisors may not see a significant change in business practice.  We are already considered fiduciaries.  However, broker/dealers (B/D) may not have it as easy.  B/Ds are generally not considered fiduciaries to retirement plans or IRA assets, they are instead held to a less stringent “suitability” standard.  In the light of the proposed rule, one of the chief issues B/Ds face is how to handle variable income and commissions.  Changing their business model to accept level income would likely be an onerous undertaking.  There is an unattractive alternative.  Under the DOL’s Best Interest Contract (BIC) exemption, the broker/dealer may be exempt from the fiduciary rules if certain requirements are met.  These include:

  • obtaining a written contract prior to the offering of any advice,
  • supplying the prospect information and costs for every investment they could own,
  • providing performance information on each investment,
  • fully disclosing compensation arrangements and
  • maintainging this information for a period of six years.

In addition to this, the aforementioned information must be maintained a public website. Consider the amount of work and man-hours it would take to become compliant with the BIC exemption.  Because of this, it is expected that smaller B/D’s will exit the industry or merge with larger providers.

One of the controversial rules surrounds the “seller’s carve out” and its impact on small business retirement plans (plans with either less than $100 million in assets or 100 participants).  Under the rule as proposed, the advisor is not considered a fiduciary to the investments of these small business plans.  I question why every plan, irrespective of size, wouldn’t be required to have a fiduciary.  After all, under this specific rule, if the DOL is trying to protect consumers, why protect some of them and not all of them?

In closing, we at Parsec have been watching this unfold for months and are eager to see the final form of the rule.  Perhaps an unintended consequence is that many customers and retirement plans may have to reconsider their advisory relationship.  Regardless of the new rule, it is important to always put the best interest of your clients first.  Parsec will be prepared for whatever the DOL comes up with.

Neal

Neal Nolan, CFP®, AIF®
Senior Financial Advisor
Director of ERISA Services

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Downturns, Recoveries and Portfolio Income

The most unpleasant part of investing in stocks is definitely the periodic pullbacks. Unfortunately, these are part of the price we pay for more money in the long run.

When the stock market is going up, everybody feels good about being a long-term investor. It is the downturns that test all of our nerves and our belief in long-term investing. As one pundit put it – we can then see who the long-term “owners” of stocks are as opposed to the shorter-term “renters.”

Currently the S & P 500 is around 1946, down about 8.6% from its peak in May of 2015. The low point of the current correction was on 2/11/16, when the S & P was down about 14% from its peak. As a refresher, a correction is defined as a -10% to -20% retracement from a previous peak, and a bear market refers to a decline of more than -20%. We are currently in the 35TH correction or bear market since 1945, and during this time these have occurred about every 2 years on average. Prior to the current correction we had gone almost 4 years without a 10% pullback, so our memories of this sort of negative volatility had begun to dim.

Considering market declines of between 10% and 20% since the end of World War II, the average percentage decline is -13.8%. The average time to recover back to the previous peak level was 3.6 months from the low point. The correction we are experiencing is currently about average in magnitude, and if it were to follow historical averages we would expect a recovery sometime in early summer. Nobody knows for sure whether things will get worse before they get better, but studying past market conditions gives us some context as to the range of potential outcomes.

What do we do in the meantime? If your asset allocation is 100% stocks, we recommend that you stay with it or, if you have the ability, take this opportunity to add to your portfolio with monthly deposits (such as to your 401k or Roth IRA), periodic bonuses or other savings. If your chosen asset allocation includes fixed income, then we periodically rebalance to your target mix and add money to stocks at temporarily depressed prices.

In our portfolios that contain individual stocks, our recipe is as follows: start by focusing on high quality companies with the potential for rising earnings and dividends. Combine 35-45 such companies into a well-diversified portfolio. Regardless of what happens in the stock market over the next year, your portfolio income should be higher each subsequent year. The management teams of high quality companies with long track records of dividend increases are very reluctant to cut their dividends. Even in a recessionary environment, more companies should increase their dividends than maintain or cut them. There are many well-known companies that have increased their dividends every year for 25, 35, 50 or even 60 consecutive years. You may already own some of these companies, especially if you are a Parsec client.

Total return is comprised of two components: income and price appreciation. Over long time periods, the income component of total return has represented just under half of the overall return of the stock market. However, the variability of the income return has been much lower than that of the appreciation component. By focusing on those companies that we believe are likely to have consistent dividend growth over time, particularly for those of our clients who are retired and spending from their portfolios, we are setting up a condition where there is less uncertainty about a significant component of their overall return. For our clients with large cap mutual funds instead of individual stocks, the same general premise applies.

The equity portion of our client portfolios also includes small-cap, mid-cap and international companies, which we invest in primarily through pooled vehicles such as mutual funds and exchange-traded funds (“ETFs”). The fixed income portion is also well diversified, with a focus on short-to intermediate term, high quality instruments along with some high yield and international bonds for diversification and yield improvement.

We encourage our clients to focus on this concept of rising portfolio income to meet their investment goals and provide peace of mind during the inevitable corrections and bear markets that we will all experience at some point.

William S. Hansen, CFA
President
Chief Investment Officer

Bill

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