2019 Q1 Thoughts

Market Recap

Over the last two quarters, we’ve experienced in quick succession one of the worst quarters and one of the best quarters in U.S. stock market history. The S&P 500 Index is back hovering just beneath its all-time high reached last year. It is proof again of the folly of trying to predict short-term market performance. Foreign stocks have also rebounded sharply. U.S., developed international, and emerging-market stocks are now up 13.6%, 10.6%, and 11.8%, respectively, through March 31.

In fixed-income markets, both interest-rate sensitive and credit-sensitive sectors gained. Core investment-grade bonds benefited from a drop in interest rates, gaining 2.9%, and riskier credit strategies rallied along with equities. The flexible income funds in your portfolio outperformed investment-grade bonds as a group, and floating-rate loan funds gained over 3%.

Turning to alternatives, our allocation to lower-risk alternative strategy funds generated a positive return that beat bonds.

The Middle Path

Our take on the last six months is that times are never as bad as you fear and never as good as you hope. It certainly feels better to see strongly positive portfolio performance this quarter. But we should be careful not to extrapolate any short-term trend into the future. The drop and then snap-back rebound in stock prices during the last half year were largely driven by a policy U-turn by the Federal Reserve, not changing fundamentals. Fed decisions and statements first decreased then increased investors’ willingness to take risk. The impact of such sentiment on the markets is usually ephemeral.

In the case of December, prices did not go low enough to give us the confidence to buy more stocks. And prices have not risen so high this year (yet) that we have the confidence to reduce stock exposure. When it comes to managing your portfolio, The Gardner Group knows reacting to short-term moves is more likely to be detrimental than beneficial. That’s why we always maintain a high bar to make tactical portfolio changes. The deck must really be stacked in our favor.

The time to act is in preparation of certain scenarios playing out, not during or after. The markets factor in emerging events too quickly. It’s notable that we were already modestly underweight to equity risk before the worst December since the Great Depression. We would have loved to know in advance that the fourth quarter was going to be so ugly; we would have been even more underweight! But a much lower equity allocation could just as easily have hurt portfolio performance had the bull market continued into year-end (which it probably did in some alternate universe).

This brings up one of the conundrums all investors face today: You can reduce exposure to expensive, volatile assets (stocks) to increase resilience to a bear market, but then you face the risk of seriously uncompetitive returns should a plausible bullish scenario occur. It sounds like a Yogi Berra-ism, but it’s true: You never know the probabilities with certainty. So we’ve believed and still believe the best course of action currently is to take the middle path.

Rather than dramatically lowering equity exposure in your portfolio—something that requires getting the short-term timing right (which is hard to do consistently)—we instead maintain modestly reduced equity risk overall. We’ve preferred to protect your portfolio with alternative strategies we believe will hold up well or even benefit during turbulent times. Their short-term performance during good times can be bothersome, but ultimately any drag on returns should be low given their position sizes and risk profile. Meanwhile, we’ve tried to keep returns competitive in a bullish scenario—despite the slightly lower exposure to U.S. stocks—by investing in hybrid investments like flexible income funds and floating-rate loan funds. These funds can generate strong long-term returns, but they don’t have anywhere near the level of potential downside and volatility that stocks do.

We would obviously prefer for a bullish scenario to occur over the medium term, especially one that involves strong global growth, which should disproportionately benefit our international investments. But we have to accept there are other less rosy paths the future can take. In the event of a recession or major bear market in stocks, the liquid alternatives and investment-grade bonds we own will fund the at-bats we need to swing hard at the fat pitches markets often leave out over the plate at those darkest of moments.

Partnering with You

As you read this, the April tax season has just closed, but tax planning is a year-round pursuit for us. Offsetting taxable gains in your portfolio is part of that, but as a wealth management firm, The Gardner Group also reviews changes in tax law each year with the goal of identifying where we can further maximize your wealth. We’ll then work with you and your CPA, accountant, or tax professional to implement strategies that add value.

One recent major change has been the substantial increase in the standard deduction. To retain the tax benefits of charitable gift amounts that might fall below the higher standard deduction, we’ve been suggesting a bunching strategy to many of our clients. By combining multiple years of planned charitable gifts into one year, you can push above the standard deduction limit and receive a marginal tax benefit on the excess amount. There are a few new tax benefits as well, one of them being Section 199A. It may permit you to deduct 20% of the business income on your tax return. The rules are complex, so you’ll want to speak to your CPA or tax advisor, but the benefits are attractive if you qualify.

As always, The Gardner Group appreciates the trust you place in us, and we continue to work hard each day to earn it. If you would like to schedule a call with us to discuss any financial planning matters, PLEASE CLICK HERE.