(Tax loss) Harvest Season is Almost Here!

The kids are back in school, the leaves are changing colors, and pumpkin spice lattes – the age-old harbingers of harvest season – are everywhere. At Parsec, we are preparing for the harvest…of tax losses.

Every year, beginning in late October/early November, Parsec’s portfolio managers will scour clients’ taxable accounts for meaningful losses, which we can use to offset realized gains created from trading throughout the year. These tax-efficient trading strategies provide value to clients by minimizing their tax burden while keeping the portfolio aligned with their financial planning goals.

You might see trades from one security into another one that is similar, but not exactly the same – we do this so that you can recognize a loss while maintaining exposure to the same industry or sector, yet avoid incurring a wash sale. According to IRS publication 550, “a wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you buy substantially identical stock or securities,” either in the same account or in another household account, including IRAs and Roth IRAs. Stocks of different companies in the same industry are not considered “substantially identical,” nor are ETFs that track the same sector but are managed by different companies (like a Vanguard Emerging Markets ETF vs. an iShares Emerging Markets ETF).

Sometimes it makes sense to place a loss-harvesting trade and leave the proceeds in cash for 31 days, then repurchase the same security. We may do this for clients who have cash needs during the holiday season, with the intention of placing rebalancing trades in January when there is no more need for liquidity. When liquidity is not an issue, however, we prefer to keep the funds fully invested in another high-quality name. We may later choose to reverse the trade, once the wash sale period has expired, or we may leave the trade in place if we think it is appropriate and suits the clients’ needs.

Sarah DerGarabedian, CFA
Director of Portfolio Management

 

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Value Stocks May be Poised to Outperform

Since Parsec’s founding in 1980, we’ve touted the benefits of long-only equity investing.  This includes owning individual stocks, mutual funds, and exchange traded funds (ETFs).  We’ve also maintained the same investment style over the last thirty-seven years.  Regarding funds, Parsec’s investment policy committee (IPC) focuses on low fees, higher-quality holdings, and managers with long track records of outperformance.  When researching individual stocks, we take a value approach, favoring higher-quality companies that trade at a discount to history or peers.

While history shows that value stocks have outperformed growth stocks over most market periods, in recent years growth stocks have delivered higher returns.  In this email we’ll discuss what we mean by value versus growth investing and why we believe value stocks are poised to outperform going forward.

Different stock investors define “value investing” differently.  However, most agree on a few basic principles.  In general, value investors prefer stocks that trade at discounts to their intrinsic values.  Often this happens when a stock’s valuation falls below its long-term historical average or that of its peers.  Another tenet of value investing is margin of safety.  This means selecting stocks that can deliver healthy total returns even if current growth assumptions fall short of expectations.  While we consider ourselves value investors, we will add select growth stocks to the Parsec buy list when expectations look reasonable and a company has a competitive advantage.  In other words, when we think a stock has a reasonable margin of safety.

In addition to a value-based stock selection approach, Parsec’s investment philosophy also has a quality bias.  This means we prefer companies with strong cash flows, consistent earnings growth, a long history of dividends, and above average returns on invested capital.  We also favor companies with strong balance sheets that can withstand different market environments and even gain market share during difficult economic periods.

Looking back over the market’s history, value stocks have outperformed growth stocks by an average of 4.4% annually from 1926 to 2016 (Bank of America/Merrill Lynch).  More recently from 1990 to 2015, value stocks outperformed growth stocks by just 0.43% annually.  The spread has since reversed and in the last ten years value stocks have lagged growth stocks by 3% annually through the second quarter of 2017*.

The shift in leadership from value to growth stocks coincided with the start and continuation of the Federal Reserve’s massive monetary accommodation programs known collectively as quantitative easing (QE I, II, and III).  Those programs put additional downward pressure on interest rates.  In the face of low or no yields and the slowest economic expansion after a deep recession in over 120 years, investors demonstrated a preference for growth stocks over value stocks.  They were willing to pay up for companies delivering higher growth in a world where growth had become scarce.  Throughout the last ten years value stocks have occasionally outperformed, but usually in tandem with a steepening Treasury yield curve and thus improving growth expectations.

Because asset prices and interest rates are inversely correlated, very low interest rates over the last decade have led to above-average asset valuation levels.  This has been even more pronounced among growth stocks as investors have been willing to pay a premium to own them in a slow growth environment.  As a result, typically higher-priced growth stocks are even more expensive today.

Sticking to our value- and quality-biased investment approach has admittedly been a headwind in recent years.  However, we believe higher-quality stocks trading at a discount are poised to outperform.  Growth stocks currently trading at premium valuation levels will have further to fall in the event of a market downturn.  As well, low interest rates have prompted corporations to take out record debt levels.  As rates begin to rise, higher-quality companies or those with strong balance sheets and robust cash flows will be better able to service their debt levels, even during an economic downturn.  While maintaining our investment approach through the current environment has been challenging, we feel confident that investing in higher-quality companies trading at discounted valuations will reward clients over the long-term.

*References the Russell 3000 Growth Index and the Russell 3000 Value Index

The Parsec Team

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Gen Y, Say Yes to Stocks!

It started with anecdotal evidence: a conversation with a co-worker about a group of professionals he spoke to about their 401k. The wiser (by which I mean older) folks were asking about the outlook for the economy and how they could maximize their 401k contributions. But the young man in the group, who was in his early 30s, expressed complete contempt for the stock market.  All of his money, he said, was in cash. Then a client of mine who is nearing retirement called me just to tell me about a dinner he went to where the topic of investing came up.  He was shocked at how vehement the young people at the table were about not investing in stocks due to their risk.

Since then I’ve read about a growing body of evidence coming from surveys and other research that suggests that the younger generations are too conservative in their investments. Gen Y is saving but not investing aggressively enough. The problem is that they distrust financial institutions (we don’t count) and believe another financial meltdown is all but imminent.

Gen Y, we don’t blame you. You were in your teens on Sept. 11, 2001, which had to have rocked whatever concept of stability you had. By the time you were old enough to know what the stock market was, the technology-driven crash of 2001-2002 was causing strife in budding 401k plans. And just when you were starting to dream about home ownership the housing market was spiraling out of control in 2008-2010. Many of you watched your parents go through extreme financial duress during this time period, something you were well old enough to understand.

It’s no wonder that Generation Y is too conservative. Your generation doesn’t have the benefit of personally experiencing the roaring 80s and 90s to boost your confidence about the markets. You don’t know who Crockett and Tubbs are. Looking at historical stock returns on paper just isn’t the same as living through it. And it’s hard to understand why men ever wore over-sized shoulder pads, but they did. Even the last five (amazing) years of positive stock markets seems like mere payback for the horror of 2008-2009. Despite this, we have to remember that stocks have historically provided the highest long-term return. No matter what your steadfast beliefs are about the future of the economy, it probably carries no more predictive capacity than the next differing opinion. That’s why we look to history as a guide, rather than trying to guess the future.

When you look at stock volatility over long time frames, it isn’t nearly as risky as the day-to-day movement would have you believe. In the last 87 years large company stocks’ annual returns ranged from -43% in the worst year to +54% in the best. That’s quite a spread! But those same stocks in any given 20 year period (starting on any given day in any year) averaged returns in a range of +3% in the worst 20-year period to nearly +18% in the best 20-year period. That includes the Great Depression and the market crashes of this century. That’s a lot easier to swallow. You have a long time before liquidating your accounts for retirement – probably more than 30 years, so you should be taking a longer term view.

And let’s not forget about inflation. That cash that’s in your 401k is doing less than nothing for you. Long run inflation is around 3%. If you are getting a 0% return on your cash, that is actually -3% in real dollars, guaranteed.

Saving money isn’t good enough. Millennials need to invest with a little more oomph. Yes, diligently putting away $500 a month for 30 years is hard work and no one wants to see their money shrink. But consider this: if you get a modest 4% average return on those savings, you will have $347,000 in retirement; if you double that return to 8% an amazing thing happens: $745,000. Taking risk means a lot of ups and downs along the way, but potentially twice the money in the end. If you can go cliff-jumping with your friends, you can buy stocks, right? (No? Was that just my friends?)

There is no reward without risk, to be sure. Any investment plan should be done with the full comprehension of the volatility, range of outcomes and potential for return. There certainly is risk in losing money in the stock market over short and intermediate time periods. However, those losses only become permanent if you sell out during periods of decline. It seems all but certain that an all-cash/fixed income portfolio is doomed to growth too slow to possibly reach any long-term financial goals.

 

Harli L. Palme, CFA, CFP®

A Gen-exer who believes all of the above applies to her generation too, except the part about over-sized shoulder pads.

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Fire Tower Watchman

I recently read a newspaper article about a man whose career spanned three-and-a-half decades. It was something that he loved doing and even spent long hours fulfilling his duties. What struck me wasn’t his job (a fire tower watchman), or even the fact that he was often snow bound for long periods during winter months. It was his take-life-as-it-comes attitude and dedication to his job.

After reading this article, I began to think about the fire tower watchman and how we at Parsec Financial try to provide security to our clients. One of the obvious ways we help to provide financial security is through our investment management process. Our Investment Committee regularly reviews the investments we buy and hold for all of our clients and cycles through each of them 3-to-4 times each year. There are other ways we help our clients too.

Financial security also comes in the form of a review of insurance needs. While we typically steer away from permanent life insurance policies, we feel that term life is a good layer of protection for families with a mortgage, young children, or other financial commitments that could drain a net worth in the event of a premature death. We normally recommend carrying enough insurance that would pay off mortgages and put children through college.

Another important policy to hold is a personal disability insurance policy; such policies provide income, usually income tax-free, during a time when it’s needed the most. For the same reasons that one should have a life insurance policy, the disability policy can protect individuals and families by helping them pay for mortgages, utilities, medical bills, and maintain a certain standard of living.

I know that we’re not heroic firemen or the vigilant watchman that I read about. But as I think about the services we provide and genuine nature of helping our clients with their investment portfolio and also helping them understand how to protect their net worth, I wonder what the employees of Parsec would say about our careers after 3½ decades of work. My feeling is that each of us will look back over our careers and have a sense of pride, knowing that we acted in our clients’ best interests and helped to provide a layer of financial security like the fire tower watchman did for the mountain ranges he served.

Neal Nolan, CFP(R)
Financial Advisor

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SDG Market Indicator: Future Nobel Prize Winner?

Every day, it seems someone has a new model that claims to predict the next stock market meltdown or boom.  Two of my colleagues, Mark Lewis and Sarah DerGarabedian, and I had a stock market theory we tested a couple of years ago.  We called it the “SDG Market Indicator.”  

At the time, Sarah’s almost one-year-old son was having some difficulties sleeping through the night.  Whenever she did not get a good night’s sleep, we noticed on most of those days the stock market dropped.  Over a 48-day period, we compared her sleep cycle against the market’s performance.  If she slept well the night before, the market increased 42 percent of the time.  The market was either flat or declined 58 percent of the time when she had an average to bad night’s rest.  

You are probably saying to yourself, “This is the stupidest thing I have ever heard.”  You are right.  Some people accept far-fetched theories like the SDG Market Indicator as sound market guidance, though.  As they chase the next theory’s prediction, they risk losing more than they could potentially gain.  

Market timing statistically does not work.  A study by Morningstar highlights the dangers of market timing.  This study shows that, during the period 1926 – 2009, an investor who invested $1 in stocks would now have $2,592.  The study also shows that if that investor missed the 37 best months during this time frame, but was otherwise invested in stocks, the investment would only be worth $19.66 at the end of 2009. 

At Parsec, we prefer to take the long-term view when evaluating the market.  It is impossible to predict on a day-to-day basis what the market will do.  However, as studies have shown, the market will eventually recover from declines.  It is all part of the cyclical nature of financial markets.  

The next time you see a hot new theory, just think of the SDG Market Indicator.  Now, I am off to force feed Sarah a turkey sandwich and slip an Ambien in her tea.  It is time for a few positive days in the market.

Cristy Freeman, AAMS
Senior Operations Associate

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