The Enrichment Group http://theenrichmentgroup.com Financial and Investment Strategies for a Lifetime Thu, 30 Jun 2016 21:44:00 +0000 en-US hourly 1 https://wordpress.org/?v=4.7.3 How the New Financial Law Affects Pinnacle Clients http://theenrichmentgroup.com/market-commentary/how-the-new-financial-law-affects-pinnacle-clients/ Wed, 13 Apr 2016 13:23:11 +0000 http://theenrichmentgroup.com/?p=2830 As the laws governing how financial professionals guide client retirement assets are set to change, financial advisors are being required to place the interests of their clients first. With this change, all advisors must not only recommend investments that are suitable for their clients, but more importantly, they must act as a fiduciary and place their clients’ interests ahead of their own.

So how will this affect the investments of Pinnacle clients? It won’t.

Since we opened our doors in 1993, we have been registered as Investment Advisors and served as a fiduciary to every client account. Up until now, financial advisors registered as Registered Representatives (RR) of a Broker/Dealer have been able to recommend investments that were merely suitable for a client. The new law will require the RR to become a fiduciary with a greater level of responsibility to all clients (in other words, they’ll be required to be more like us).

The new law only applies to retirement accounts and will often be a factor when clients seek to rollover their 401k plans to other investments to fund their retirement. These are the large and life-changing investments that the law is seeking to protect. Unlike the new ruling, at Pinnacle, we act as a fiduciary for all accounts — not just retirement accounts. In our work with clients, we offer an array of planning and portfolio management services with a focused approach on managing risk, fees, and taxes — all to benefit our clients.

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VIDEO: Watch Inside the Investment Committee 2016 http://theenrichmentgroup.com/market-commentary/video-watch-inside-the-investment-committee-2016/ Mon, 28 Mar 2016 13:13:58 +0000 http://theenrichmentgroup.com/?p=2816 We are pleased to present a recording of “Bearish Tendencies (and Silver Linings),” our 2016 Inside the Investment Committee event held in Columbia, Maryland.  This event gave attendees an inside look at the thoughts, views, and strategies of our investment team.  Many of you attended our sister presentation in Miami, and we would be excited to have you join us next year.
As always, please call us if you have any comments or questions.

 

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Hear Ken Solow Discuss the Election and the Markets http://theenrichmentgroup.com/market-commentary/hear-ken-solow-discuss-the-election-and-the-markets/ Sat, 19 Mar 2016 01:12:43 +0000 http://theenrichmentgroup.com/?p=2822 A few days ago, Ken Solow (Founding Partner and Chairman of the Investment Committee at Pinnacle Advisory Group) appeared on The Baltimore Sun columnist Dan Rodricks’ popular Roughly Speaking podcast to discuss the election’s effects on the market.  Many of you met Ken at our client event last July.  Click here to listen — Ken’s segment begins at 50:55.
 
As always, please call us if you have any comments or questions.
 
Read more…
 

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Bearish Tendencies and Silver Linings http://theenrichmentgroup.com/market-commentary/bearish-tendencies-and-silver-linings/ Mon, 01 Feb 2016 17:14:23 +0000 http://theenrichmentgroup.com/?p=2810 2015 had many twists and turns, but from a financial market perspective, it was effectively a road to nowhere when looking across a variety of asset classes. In U.S. equity markets, large company stocks (large cap) barely moved as just a few sectors and stocks were big winners. In the broad market, many stocks performed far worse than the large cap averages and gave investors the false impression that the market was generally flat. On the contrary, a broader measure of the market which consists of 1700 equally weighted stocks was down roughly 7% on the year, and helps to highlight how skewed the major indices were, due to just a few large companies that had good years.

Outside of the U.S., global markets were all over the map. Japan had a solid year, but many other parts of the world did not fare so well. The worst region within equities was found in the emerging market world, where the broad indices were down double digits and select regions were mired in severe commodity related bear markets. Commodity futures continued their descent in 2015 and registered losses of approximately thirty percent. Fixed income investments were no easier to gauge—while intermediate government bonds and municipals had a solid year, riskier fixed income instruments closed out the year with solid losses due to exposure to energy companies and a sagging economic backdrop.

2016: New Year, Same Old Story

While the calendar has changed, the investing landscape is mostly a continuation of what we witnessed in the second half of 2015. Our last quarterly piece was titled “A Time for Caution,” because the bull market was aging and becoming overvalued as it had finally met technical conditions that were turning negative.

As we start the New Year, not much has really changed from a big picture perspective. We continue to deal with a global business cycle that is slowing, valuations that are high, and a technical environment that continues to break down. In short, it looks like the transition from bull to bear market is taking hold within the equity markets. Given this, we believe we should continue to focus on risk management, which is why we are currently managing our portfolios defensively. This defense has consisted of shifting the holdings within our portfolios to own less risky assets and more fixed income (bonds). We have concentrated the equities that we own into more defensive holdings that are less exposed to cyclical areas of the market.

Corrective Activity or a Cyclical Bear Market?

2015 may have gone out like a lamb for the major averages, but 2016 has come in like a lion. The sudden and violent drop at the start of 2016 puts us in corrective territory and we have already made a substantial downside adjustment in response to the volatility.

The crucial question here is whether or not the current adjustment is a correction within the ongoing bull market, or the start of a cyclical bear market in stocks? We believe the market has been displaying textbook bearish tendencies based on the changes in the market that have been developing for the past few quarters, including some that helped warn us that the market’s internal condition was compromised prior to the latest drop in the headline indices. Along with deteriorating technical conditions, we are also concerned that an expensive U.S. market is now clashing with a methodical slowdown in the global economic backdrop, a slowing earnings environment, and an important change in monetary policy from the U.S. Federal Reserve.

As we align the evidence today, it would appear that the transition from a bull to bear market has begun to pick up steam, and that the major averages have finally entered the gravitational pull of a normal and healthy cyclical bear market cycle.

How Long and How Deep?

Given that we believe a down trend is in motion, how long and protracted might it be? While there is never a way to gauge the depth and severity of a cyclical trend with precision, we think history can be a useful guide. One method analysts have used to gauge the severity of a bear market is to compare prior bear market periods to those that were associated with recessions, and those that had no connection to a downturn in the economy. While numbers differ by market and exact time frame analyzed, the U.S. studies we have examined would conclude that cyclical bear markets are typically longer and deeper if a recession is involved. According to data by S&P IQ, the average bear market in the S&P 500 since 1929 is about 35%, with a duration of about 21 months. If history is any guide, our best guess is that this bear market should be contained to somewhere between 20 and 30%, and if we escape it without a recession, then we will likely land on the lighter side of that range.

Recession or No Recession?

The global economic environment is extremely weak. The combination of a volatile commodity market and the persistent weakness in China has produced fragile economic links within the emerging market universe, for a number of quarters. In stark contrast to the emerging world, the developed regions have been enjoying a low but stable growth profile. In general, the developed world has benefitted from low inflation and interest rates, and from central banks that have been in overdrive to make up for the scarcity in world aggregate demand that has been a hallmark of the post Great Recession period. Unfortunately, the world is highly globalized, and when a large portion of the globe is having a severe problem, it is hard for any single economy to remain unaffected. It would seem that the problems in the emerging market world are finally beginning to disrupt the goldilocks environment the developed world had become accustomed to over the past few years.

Last quarter, our forecast was for a U.S. economy to continue slowing, primarily due to the weakness abroad that was beginning to infiltrate our shores. While recession was not our base case, we did note that risks were rising as we began to see a variety of regional economic surveys slowing, and manufacturing numbers were feeling the pull of weak world growth and a strong dollar environment.

As we start 2016, we believe that 2015 fourth quarter growth will come in very close to recessionary levels, though we still believe the economy will likely skirt negative numbers (even if by an anemic margin). It would also appear that the first quarter is setting up to be quite weak as well. While we are not calling a recession just yet, we think it is fair to say that growth is low enough to continue to cause problems for earnings and the stock market. So far, our non-recessionary call has kept us in the short and shallow bear market camp. However, recent data is not encouraging, and our view could change over time. If it does, it could alter our long term view and the amount of de-risking we ultimately employ during this cycle.

Wealth Generating Opportunity

When markets turn down and the media whips up into a negative frenzy, it is easy to lose the larger context. But if we remove ourselves from the day to day craziness and undertake a more clinical evaluation of a cyclical bear market, there are actually many silver linings for those looking to build wealth over time.

The first silver lining is that cyclical bear markets help clear out some of the excess that has been built during the prior cyclical bull phase. In essence, a bear market is nature’s way of removing the weakest hands from the market so that a healthy balance between fear and greed can coexist. Bull markets are nice as they run and build wealth, but if they don’t have occasional pullbacks, they turn into bubbles which can be devastating when they eventually pop (see the current drop in oil, the prior drop in gold, the drop in the NASDAQ in 2000, etc.). So let’s just accept that cyclical bear markets are a natural part of the investment cycle, and are occasionally necessary to cleanse excess, and recalibrate market sentiment and valuation.

Beyond restoring a natural balance to markets, the tail end of a bear market is what ultimately gives investors the best possible chance to build wealth. As valuations drop and prices get marked down, investors ultimately get a chance to pick up assets with robust long term appreciation profiles and greater margins of safety. The run off the 2009 and 2011 bottoms were both healthy moves, and have put stocks in a place where some froth needed to come out of the system to allow for adequate long run gain potential.

When viewed through this prism, a cyclical bear market is like a sale on quality assets—and who doesn’t want to go shopping when things worth buying are on sale? The last few years have brought about an aged condition, which didn’t give us much enthusiasm to overweight risk assets. But a cyclical bear market should help reset valuation profiles and finally give us an opportunity to increase exposure to these assets at very cheap prices.

So in the end, cyclical bear markets can be something to get excited about for those willing to reflect on the mission of building long term wealth.

Conclusion

When markets move quickly and confusion reigns, it’s easy to make mistakes. We use a systematic approach in managing our portfolios and the evidence we follow has helped us identify this period as a rocky one, while giving us the flexibility to alter allocations and become defensive in front of the latest volatility. We’ll continue to monitor market conditions and respect this bear market while it runs, but we’ll also keep an eye out for evidence that turns in a more positive direction.

Warren Buffet has long talked of being fearful when others are greedy and greedy when they are fearful. We won’t rush back into this market, but we will keep an eye out for that point of maximum fear, where we can attempt to put Buffet’s principals into action and get a chance to build long term wealth with a greater margin of safety.

Our Strategies

Dynamic Prime Series

The Dynamic Prime strategies are positioned defensively due to a careful evaluation of the evidence and a determination that the market cycle is in a downtrend. Since the middle of 2015, portfolio construction has been incrementally reflecting this view through a series of adjustments that have reduced overall portfolio volatility from 100% of benchmark risk to approximately 75%. This reduction in volatility is the byproduct of a less aggressive allocation to stocks and risky assets, and a higher allocation to defensive bonds and cash. It also reflects a reduction in equity sectors and countries that are cyclical and more volatile, and an addition to those that are typically more defensive.

Dynamic Market Series

The satellite of the Dynamic Market strategies, comprising 30% of the portfolios, remained on a defensive posture and avoided stocks altogether throughout the fourth quarter. Such defensive posture was the result of our valuation model for the S&P 500 Index continuing to indicate that the market is overvalued. Such condition is by itself sufficient for the strategy to remain in a defensive posture, regardless of the message coming from the technical component of the model.

As a result, the strategy entered the fourth quarter with its satellite fully invested in short-term T-bills. However, the technical component of the model, applied to the Barclays Aggregate Bond index, switched from a “sell” signal to a “buy” signal on October 5th, as a result of a renewed uptrend in the index. On October 6th, the satellite was traded accordingly by selling the entire position in short-term T-bills (SHV) and initiating a position in the Barclays Aggregate Bond index (SCHZ), which is where it remains invested at present.

Dynamic Quant Series

The Dynamic Quantitative strategy entered the fourth quarter with its satellite in a defensive posture and fully invested in the Barclays Aggregate bond index (SCHZ). This was a result of the technical component of the model applied to the MSCI USA index, which issued a “sell” signal in the third quarter (September 3rd) after the index broke its uptrend. However, on November 6th the technical component switched from a “sell” signal to a “buy” signal. This happened as a result of two joint conditions: the market’s oversold condition registered in September, and the market’s strong rebound. The technical component of the model is designed to interpret these two conditions as a sign that the market is about to re-establish its trend, and therefore it decided it was time to buy back into stocks. As a result, on November 9th the satellite was traded by selling the entire Barclays Aggregate Bond position (SCHZ) and investing the proceeds according to the sector rotation component, which was prescribing large overweights to the financials and technology sectors, and more moderate overweights to the energy and consumer staples sectors. The consumer staples sector was later downgraded on December 11th in favor of the telecommunications sector.

The Dynamic Quantitative satellite ended the year fully invested in equities, as described. However, as we entered 2016, a renewed bout of weakness and heightened volatility in global markets caused the trend of the MSCI USA index to once again deteriorate, resulting in the Fail-Safe issuing a new “sell” signal for the MSCI USA index on January 21st. As a result, on January 22nd we liquidated the equity sector ETFs held in the satellite and invested the proceeds in fixed income (SCHZ), which is how the satellite remains invested at present.

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5 Estate Planning Tips for 2016 http://theenrichmentgroup.com/financial-planning/5-estate-planning-tips-for-2016/ Fri, 29 Jan 2016 19:53:03 +0000 http://theenrichmentgroup.com/?p=2807 We are pleased to share with you an article written by David Kauffman, a Wealth Manager at Pinnacle Advisory Group and a former attorney. We invite you to share it with anyone who may be interested.  This is general information that may not apply to your specific situation.  As always, please call us at (305) 274-1600 if you have any comments or questions.

With the new year upon us, it’s a good time to make sure your plans for the future are up to date and you have the proper tools in place. With that in mind, we encourage you to consider the five estate planning tips below.

1.     Make sure your will and estate planning documents are up to date. The primary purpose of these is to distribute your property to your chosen beneficiaries after your death. Be sure to name a Personal Representative (executor) who will manage and settle your estate and a Trustee to manage any trusts that may exist.

2.     Create an Advanced Medical Directive to let others know what medical treatment you would want and a Health Care Power of Attorney to allow a specific person to make decisions on your behalf. Consult an estate planning attorney for more information and guidance.

3.     Create a Healthcare Power of Attorney for your adult children, particularly as they leave for college, so that you can speak to doctors as an agent for your child.

4.     Create a General Power of Attorney, also known as a Financial Power of Attorney, to appoint a specific person to represent you in making decisions should you become incapacitated.

5.     Check the beneficiary designations on your retirement accounts and insurance policies. Are they up to date and allocated the way you desire?

If you have questions about your plans for the future and what is needed during life and after death, please consult your wealth manager and an estate planning attorney today.

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A Message from the Chairman of the Investment Committee at Pinnacle Advisory Group http://theenrichmentgroup.com/market-commentary/a-message-from-the-chairman-of-the-investment-committee-at-pinnacle-advisory-group/ Fri, 22 Jan 2016 17:01:48 +0000 http://theenrichmentgroup.com/?p=2797 We are pleased to share with you a message by Ken Solow, Founding Partner and Chairman of the Investment Committee at Pinnacle Advisory Group.  Many of you met Ken at our client event in July.  Since almost all of our clients are now in Pinnacle’s investment models, we thought that you might like to read his thoughts on the recent stock market decline.  As always, please call us if you have any comments or questions.

The S&P 500 Index is down over 12% from its high last May, which qualifies as a market correction but not a bear market. In fact, it’s been quite a while since we experienced our last bear, although it may not feel that way. From April to October of 2011, the stock market declined by 19.39% on a closing basis. While experts can debate whether this meets the definition of a bear market (which are typically defined as 20% declines), those who remember it will recall how scary it was. By the time the market bottomed in October, many were recalling the 2007–2009 bear market, which was gut wrenching for everyone. During that excruciating market decline, the S&P 500 Index fell by 55% and the economy tumbled into a deep recession. It is only in hindsight that we can see that both the market bottom in 2009 and the October low in 2011 marked important market bottoms. Since October of 2011, the S&P 500 Index rallied 94% to its eventual high set in May of last year.

Since the last mini-bear, we’ve experienced several market declines that offered their own opportunity for intestinal distress. Here’s a quick list:

April to June 2012: -9.9%.

September to November 2012: -7.6%.

May to June 2013: -6%

Jan to February 2014: -6%

September to October 2014: -7.4%.

Which brings us to last year’s 12.25% decline from July to August and the latest 8.5% market decline measured from the beginning of this year to yesterday (January 21st). The best investors can process these short bursts of market volatility without much emotion, though it’s hard to do. Bear markets are frightening, and nowadays smaller market corrections can be just as scary, because we think of them as a possible precursor to disastrous bear markets. In the short run, maybe the best we can do is acknowledge our feelings and hope that our logical left brain can take over while our emotional right brain is anxious.

Here are a few thoughts to help you sleep a little bit better while the news seems to be filled with “China did this,” “Interest rates did that,” ”Geopolitics are a mess,” ”Presidential candidates said that,” and “The stock market suffered another decline.”

  1. Pinnacle clients choose investment policies that make sense based on their long-term financial plan. Very few of them experience portfolio volatility even close to the market volatility they read about when pundits discuss “the stock market,” and most clients have a diversified portfolio that defends against market risk.
  2. The Pinnacle investment process is designed to evaluate market risk at all times and gives the investment team the flexibility to reduce portfolio risk so that our managed portfolios can be even less volatile than your portfolio policy. A balanced portfolio is less volatile than the market, and Pinnacle’s Prime Series portfolios can be even less volatile than the balanced portfolio benchmark because of the way we manage for risk. Pinnacle’s investment team has correctly evaluated current market conditions and Pinnacle portfolios are now experiencing less volatility than both the broad market and our benchmark portfolios. At the moment, this means that in a falling market, you’re getting a double bang for your buck.
  3. Rick Vollaro and the rest of Pinnacle’s investment team is very experienced. They have worked together as a team for a long time and have managed money through a variety of market conditions, including many market corrections and two major bear markets. They are working hard to properly assess possible risks and opportunities.
  4. Understanding that portfolio volatility is a normal component in long-term investing may help reduce the inevitable stress you feel when checking your portfolio statements in a bear market. As portfolio values decline in a bear market your Wealth Manager can help you better understand the impact of lower values in your financial plan. Your Wealth Manager knows you very well, understands your concerns, and would be pleased to discuss how the news and recent volatility impacts your portfolio. Feel free to call your Wealth Manager to discuss any portfolio related anxiety you’re feeling.

Experts disagree if recent market declines are the precursor to a new bear market. I will leave it to Pinnacle’s investment team to opine on how severe the drawdown might be. At the moment, it’s important to understand that market volatility is part of the sometimes ugly process of taking risk with capital — without it, it wouldn’t be possible to beat inflation and achieve your financial goals over time.

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A Peek At The Market http://theenrichmentgroup.com/market-commentary/a-peek-at-the-market/ Wed, 20 Jan 2016 21:59:45 +0000 http://theenrichmentgroup.com/?p=2792 While 2015 had its share of volatility and ended with virtually no gains in stocks, 2016 sprinted to the downside with volatile global markets, a bifurcated U.S. economy, and the first rate hike in a decade.

As we outlined in October, the global economy is slowing and the issues in China and emerging markets are at the epicenter of the world’s problems. By our estimates, between 30-50% of world GDP is directly or indirectly linked to China’s growth through various trade links. So while some believe that the U.S. economy is strong enough to simply brush off the effects of a major slowdown in China, we feel that decoupling is a dangerous possibility. Furthermore, while our base case has been that the U.S. will be able to maintain a low trajectory growth path, we believe the U.S. is currently slowing, as the drag in world trade is now showing up.

We believe the combination of an aged bull market, poor valuation, and a technical backdrop that has finally broken down, has produced an environment that demands ongoing risk management. To manage the risk in our portfolios, we have been adjusting our holdings by selling some risk assets and exchanging others for holdings with less risk. This has been a gradual process as we monitor many factors to guide our decisions. We continue to take a cautious approach in managing our portfolios and have further reduced the risk over the past two weeks. The changes within our portfolios have been primarily rotations between U.S. and International markets, and the general theme is to own more defensives and less cyclical holdings. In the fixed income area, we moved out of a merger arbitrage alternative to reduce our exposure.

As we move forward in 2016, the market’s path will be determined by a variety of factors including how stocks digest the central bank policy, inflation, currency volatility, and earnings/valuation. Looking forward, one of the silver linings to any correction or a bear market is that it tends to produce cheaper valuations which can lead to a wider margin of safety that actually improves the long-term return profile for equities. As we manage risk in a down market and raise cash, it provides us with the opportunity to buy assets at cheaper prices to build long-term wealth.

For more information about our outlook and strategy going forward, please look for our 2016 Market Outlook later this month.

Rick Vollaro
Chief Investment Officer
Pinnacle Advisory Group
www.PinnacleAdvisory.com

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Did Congress Just Kill Your Social Security Strategy? http://theenrichmentgroup.com/financial-planning/did-congress-just-kill-your-social-security-strategy/ Fri, 30 Oct 2015 04:00:59 +0000 http://theenrichmentgroup.com/?p=2785 If you were hoping to execute a ‘File and Suspend’ collection strategy of your Social Security benefits, you only have a few months remaining. Under this week’s budget legislation, Congress is killing off the various “File and Suspend” and “Restricted Application” strategies to allow spousal and dependent benefits to be paid while still earning delayed retirement credits, with just a 6-month window before the limitations start to take effect.

The File and Suspend strategy was originally passed by Congress as part of the Senior Citizens Freedom to Work Act in 2000 to allow those who had already started Social Security benefits to stop their payments and earn delayed retirement credits. In the process, however, the new voluntary suspension rules unleashed several additional Social Security claiming strategies, including various “claim now, claim more later” tactics that involved File-and-Suspend and Restricted Applications for spousal benefits.

Congress has decided to close these perceived “loopholes” in the Social Security rules. By extending the rules for deemed application, it will no longer be possible to file a restricted application for just spousal benefits; instead, filing for spousal benefits means you are deemed to have filed for all benefits (spousal and retirement) and simply get whichever is higher. This eliminates the ability to take one, and switch to the other later. And with an extension of the “suspension” rules that stipulate suspending an individual’s benefits, it will also suspend any benefits to other people based on the same earnings record.

Perhaps most notable for the new Social Security crackdown, though, is the effective date for the rules. While the new limits to Restricted Application will not apply to anyone who is already age 62 or older in 2015 (i.e., those born in 1953 or earlier), the new crackdown on File and Suspend will kick in 6 months from now (thanks to a recent amendment to the original legislation), grandfathering anyone currently going through file-and-suspend but limiting anyone who tries to suspend benefits in the future. Beyond the 6 month point (sometime around May of 2016 depending on the exact date the President signs the legislation next week), anyone who suspends will find that no benefits will be payable until the individual who suspended chooses to reinstate benefits (either to restart them now, or finish waiting until age 70).

Notably, the crackdown on these voluntary-suspension-related tactics doesn’t actually kill the rules for voluntary suspension itself, which remains on the books. But now, aside from a few esoteric scenarios (including the recent Hold Harmless Medicare claiming strategy), voluntary suspension will be relegated to those unique scenarios where someone truly started benefits early, has had a change of mind and wants to stop them to earn delayed retirement credits, and who plans to start benefits again at age 70. Of course, ideally those who wish to delay benefits for the value of earning delayed retirement credits will simply delay from the start to maximize the benefit, which makes voluntary suspension a moot point altogether for most retirees in the future.

Michael Kitces, CFP®, MSFS, MTAX, CLU®, ChFC®, RHU®, REBC®, CASL®
Director of Planning Research, Partner
Pinnacle Advisory Group, Inc.

For more information on the new restrictions, see Michael’s in-depth post, “Congress is Killing the File-and-Suspend and Restricted Application Social Security Strategies,” at his blog, www.Kitces.com.

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Market Review Fall 2015 http://theenrichmentgroup.com/market-commentary/market-review-fall-2015/ Tue, 20 Oct 2015 18:02:45 +0000 http://theenrichmentgroup.com/?p=2773 The third quarter came in like a lamb and went out like a lion, as the return of volatility hit risk assets hard across the globe. As in previous quarters, emerging market stocks and commodities suffered double digit declines as markets continue to deal with the end of the commodity super-cycle and the mix of structural and cyclical problems reverberating throughout the emerging market complex. But the big news of the quarter was a catch-up in developed markets that had previously appeared impervious to the problems that were festering in the developing world.

In August, large developed markets that include the U.S. dropped quickly and in unison. The three day drawdown in August was one of the fastest on record, highlighted by a 1,000 point drop in the Dow Jones Industrial Average during the first 10 minutes of trading. The speed of the move caught investors off guard, and shook confidence around the globe. Safe haven instruments such as bonds, cash, and the U.S. dollar caught a bid off the turmoil in risk assets, though returns for the quarter were still somewhat muted given the amount of distress in risk assets across the globe. By the end of the quarter investors were left to assess whether they had witnessed just another correction in a bull market, or whether the volatility was the beginning of a cyclical downturn in stocks that might bring about a more meaningful move in risk assets.

Global Economic Cycle: Slowing

We believe the global economy, and particularly the issues in China and emerging markets, are at the epicenter of the world’s problems. By our estimates, between 30-50% of world GDP is directly or indirectly linked to China’s growth through various trade links. So while some believe that the U.S. economy is strong enough to simply brush off the effects of a major slowdown in China, we feel that decoupling is a dangerous possibility. Furthermore, while our base case has been that the U.S. will be able to maintain a low trajectory growth path, we believe the U.S. is currently slowing, as the drag in world trade is now showing up here.

There are some who believe that the U.S. is firing on all cylinders, arguing that our consumer-led economy is poised to benefit from the Chinese and emerging markets malaise (given that current low interest rates and low inflation are byproducts of the slowdown and busted commodity super-cycle). We agree that there are some positive side effects from a slowing China, and we’re hopeful that consumers will enjoy these inputs on a lag and support the economy. But we are also realists, and at this point it is hard to deny that U.S. data has started to develop some cracks in the armor.

For example, in the month of September all seven Federal Reserve district manufacturing surveys declined. In addition, signs of credit stress have materialized in the junk bond market, indicating growing concern that default rates may soon rise, led by energy-related companies struggling with much lower oil prices. Housing and employment have been solid areas within the economy, but even they have taken a few blows over the last month. While we aren’t calling for a recession yet, we do believe that the risks to the U.S. economy are growing.

Bottom Line: Overall the evidence is mixed, with global conditions looking mildly bearish, and the U.S. slowing.

Global Monetary Policy: Mixed Settings

We have come to the conclusion that watching central bankers has become such an important part of the investing landscape that it deserves its own category. Currently global policy settings are diverging, with international central banks mostly easing policy through various mechanisms, while the U.S. Federal Reserve is preparing to exit the zero interest rate policy that has dominated the landscape since the Great Recession. This leaves conditions mixed, but also creates uncertainty  about how markets will respond to the prospect of a monetary tightening cycle in the U.S. for the first time in nearly a decade.

Bottom Line: The overall monetary policy setting is mixed with continuing liquidity abroad, and the U.S. Fed inching closer to policy normalization.

Technical Conditions: Broken

One area of the evidence that seems to be uniformly broken lies within the technical conditions of the market. Even before the latest selloff, a number of classic divergences were developing below the surface that signaled a market on increasingly shaky ground. These included such things as slowing momentum and an acute thinning in participation among many sectors of the market. When the market finally broke down in August from a long lateral phase, it did so decisively, causing an ominous surge in measures of underlying selling pressure. The best thing we can say about the market’s current technical setup is that it recently became extremely oversold, which means a bounce is likely to occur. But oversold conditions can be misleading, and what might appear to be another classic dip-buying opportunity in a bull market looks more like a classic bear trap to us (given our view that the primary trend has changed from bull to bear).

Bottom Line: Many technical measures have now broken, leaving us with a grade of “Solidly Bearish” for technical conditions.

Valuation: U.S. Still Overvalued; Emerging Markets Remain a Value Trap

One of the silver linings to any correction or bear market is that it tends to produce cheaper valuations, which can lead to a wider margin of safety that actually improves the long-term return profile for equities. Many bullish prognosticators believe the correction has already brought the broad market down to levels that are cheap, but we disagree. While it’s true that the market is a little less expensive than it was before the correction, the decline hasn’t been enough to really move the needle on the highly overvalued readings prior to the drop. Even after the correction, our valuation model suggests that over the next 5 years the S&P 500 is priced to produce less than 3% per annum. While we are not anticipating a devastating bear market that would send valuation to dirt cheap levels, we do believe the market will likely need to fall further before becoming fairly valued.

Beyond the U.S., valuation metrics show a relatively cheaper profile (though to varying degrees). Some of the larger international developed markets are marginally cheaper than the U.S., and emerging markets definitely appear cheaper on some metrics. But given poor fundamentals that are likely to get worse before they get better, we continue to believe this part of the globe represents a value trap. Emerging markets may have gotten oversold enough this year to produce a powerful trading rally, but we do not think the underperformance vs. the developed world has bottomed yet from a longer-term perspective.

Bottom Line: Valuation in the U.S. is still in expensive territory despite the recent correction, and many of the cheapest markets continue to represent untouchable value traps.

Quantitative Message

We run our own quantitative models and supplement our work with a number of sources that have been building quant models for many years. We have watched our quantitative models vacillate between mildly bearish and neutral recently, but when balanced against the independent models we follow, the broad message is that we’re in a mildly bearish period.

Bottom Line: The message of the quantitative work is mildly bearish on balance.

Independent Reads

At Pinnacle we augment our internal work with independent research from some of the industry’s leading sources. While these outside opinions are never in full agreement, they are currently offering wildly divergent views on what is taking place in markets, and how to position our portfolios to maximize returns and control risk. One clear divergence comes from a disagreement between macro strategists and market technicians: The strategists are still pretty constructive on balance, while the technicians are warning that the primary trend is now down.

Bottom Line: Add it all up and we believe the evidence is neutral, but with wide tails.

A Time for Caution

The evidence we just summarized has many nuances, and there are plenty of crosscurrents that cloud the picture. But sometimes the big picture is not really that complicated if we step back from the myriad of details that float around each trading day. We believe the combination of an aged bull market, poor valuation, and a technical backdrop that has finally broken down, has produced an environment that demands we manage risk at this time.

Of course, we will have to continue to challenge our conclusion as we move forward. If we are incorrect, it would likely mean that the global economy is actually bottoming right now and beginning to turn the corner. Should that prove to be the case, the weight of the evidence will eventually turn again, and we will reposition to at least neutral volatility weightings. In that scenario, we acknowledge in advance that there will be some opportunity cost in not fully participating to the upside (which we currently think is an acceptable tradeoff in light of the growing possibility that a bear market is beginning to unfold). At the moment the evidence suggests that it’s time to de-risk and play our hand somewhat conservatively here. Ultimately, our intention is to side step some of the pain during this cleansing process, and eventually look to reposition at better valuations to help our clients build long term wealth.

Note: The above discussion applies to the management of Pinnacle’s Dynamic Prime models. Below is a brief description> of changes during the quarter to Pinnacle’s new investment strategies that were introduced earlier this year. The Dynamic Market Series and the quantitative component of the Dynamic Quant are rules-based strategies and thus are not managed according to Pinnacle’s macro outlook.

Dynamic Market Series

The satellite of the Dynamic Market strategies, comprising 30% of the portfolios, remained on a defensive posture and was allocated to short-term T-bills (SHV) throughout the entire third quarter. This was the result of two separate components of the strategy: our valuation model for the S&P 500 index continuing to indicate that the market is overvalued, and the technical component of the model switching from a “buy” signal to a “sell” signal for the S&P 500. Either of these two conditions would be sufficient for the strategy to remain in a defensive posture, and both of them would have to reverse in order for the strategy to be allowed to move to either a neutral or aggressive posture. The choice of short-term T-bills over longer duration bonds was also driven by the technical component of the model, which was on a “sell” signal for the Barclays U.S. Aggregate Bond Index throughout the entire quarter. However, the component actually switched to a “buy” signal on October 5th as a result of a renewed up trend in the Barclays U.S. Aggregate index, and the satellite was traded accordingly on October 6th by selling our position in short-term T-bills (SHV) and initiating a position in bonds (SCHZ).

Dynamic Quant Series

During the first two months of the quarter, the quantitative satellite, comprising 37.5% of the Dynamic Quantitative strategy, remained invested in stocks according to the sector rotation component of the model, which continued to favor the Technology, Energy, Financials, and Consumer Staples sectors. However on September 3rd the technical component of the model for the MSCI USA index switched from a “buy” signal to a “sell” signal. This was primarily driven by deterioration in the market’s technical profile, which resulted from the August market correction. A “sell” signal from the technical component implies a defensive posture for the quantitative satellite of the strategy. As a result, all the equity sector holdings in the satellite were sold on September 4th, and the proceeds were held in short-term T-bills (SHV) for the remainder of the quarter. The choice of short-term T-bills over longer duration bonds was also driven by the technical component of the model, which was on a “sell” signal for the Barclays U.S. Aggregate Bond Index throughout the entire quarter. However, the component actually switched to a “buy” signal on October 5th as a result of a renewed uptrend in the Barclays U.S. Aggregate index, and the satellite was traded accordingly on October 6th by selling our position in short-term T-bills (SHV) and initiating a position in bonds (SCHZ).

Rick Vollaro
Chief Investment Officer
Pinnacle Advisory Group
www.PinnacleAdvisory.com

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5 Things You Need to Know About the New FAFSA Rules http://theenrichmentgroup.com/financial-planning/5-things-you-need-to-know-about-the-new-fafsa-rules/ Tue, 29 Sep 2015 12:42:03 +0000 http://theenrichmentgroup.com/?p=2759 We are pleased to share with you an article written by Mike Green, a Wealth Manager at Pinnacle Advisory Group. We invite you to share it with anyone who may be interested, especially those with family in high school or college. As always, please call us if you have any comments or questions.

5 Things You Need to Know About the New FAFSA Rules

With the arrival of autumn, students are back at school and either preparing for college or already navigating it. While they further their academic careers, their parents wrestle with the current or future cost of higher education and the complexities of the financial aid system.

As parents consider their options for financial aid, they learn quickly that it all starts with the FAFSA (The Free Application for Federal Student Aid) form which is the primary mechanism through which schools determine how much financial aid an applicant qualifies for. Historically, the form was due in February each year and was completed with financial information of the prior tax year (PY). Understandably, it was difficult for many families to gather the information and complete the form to meet the February deadline. Students found themselves being admitted to colleges without knowing if they could actually afford to attend. Once enrolled in college, the family would need to complete the form each year and repeat the process of collecting tax data and filing forms rather quickly to comply with the deadlines.

All of this is about to change…

An Executive Order recently signed by the President and effective October 2016 contains changes designed to streamline the process for the 2016-2017 school year. Now families can furnish financial information based upon an earlier time frame, deemed the prior-prior-year (PPY). For example, a student who will enter college in the fall of 2017 will now provide data from the 2015 tax return instead of the 2016 tax return. In conjunction with this change, the FAFSA form will now be made available for completion in October of each year, rather than January. As a result, the 2017 high school graduate in our example can apply for financial aid while concurrently applying for admission and can use the already completed 2015 tax return. In doing so, the student can learn both admission and financial aid results in basically the same time frame. For current college students, the 2015 return will be used twice – once for Fall 2016 and again for Fall 2017.

What does this mean for college applicants and their families? Some planning takeaways include the following:

  1. Easier Application Process: By using financial data of two years prior (PPY), applicants will be able to take advantage of the IRS Data Retrieval tool – an instrument through which income tax data can be pulled directly from the IRS into the FAFSA form – making the completion of the form much easier.
  2. Start Earlier: Initial college financial aid decisions will be made on the basis of an earlier time-frame – the tax year which begins in the middle of the student’s sophomore year of high school.
  3. Finish Earlier: The final financial aid decision will also be made on an earlier time-frame during college—the tax year which begins in the middle of the student’s sophomore year of college will determine aid for the senior year.
  4. Extended Family Assets: Assets held in grandparent-owned 529 accounts that are often saved for the final year of college as a planning strategy may now be used a year earlier with no negative impact on the student’s future financial aid eligibility.
  5. 2015 Deja vu: In light of the transition to the new rules, the 2015 tax year will be used twice in calculating financial aid. It will be used for the 2016-2017 school year under the existing PY system, and again for the 2017-2018 school year under the new PPY arrangement. It may be advantageous for parents to defer some income beyond 2015 if financial aid is being sought.

Michael Kitces, Pinnacle’s Director of Financial Planning Research, provides additional context and detail on his blog, which can be found at www.kitces.com. As a Certified College Planning Specialist (CCPS®), I know that educational costs — and the planning issues they give rise to have implications for students, parents, grandparents, and people of all income levels. At Pinnacle, we have the resources to help you navigate this complicated landscape. Should you have questions on this topic, be sure to consult your Wealth Manager.

Mike Green, CFP®, CTFA, JD, CCPS™

 

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