Implications of Populism

Why the anger? It’s the economy

One of the many notable characteristics of this unconventional presidential race is the broad-base populist uprising from both the left and right.  Across the U.S., pockets of workers are fed up with dead-end jobs and stagnant wages.  This anti-trade theme has resonated across both parties and will likely force changes in government policy, no matter who wins the election.

The primary cause of frustration is that workers across the U.S., especially those younger and less skilled, have faced falling standards of living since the Great Recession.  A McKinsey report[ref] Poorer than their parents? A new perspective on income inequality
By Richard Dobbs, Anu Madgavkar, James Manyika, Jonathan Woetzel, Jacques Bughin, Eric Labaye, and Pranav Kashyap, McKinsey Global Institute, July 2016 [/ref] estimates that 81% of the U.S. population experienced flat or falling incomes from 2005 to 2014.  The report shows similar results internationally with over 65% of households in 25 developed economies facing flat or decreased real income during the same time period. This equates to over 540 million people worldwide whose quality of life has not improved, many of whom are voicing their anger in elections.  As we see in the U.S., these concerns are being integrated into both parties’ platforms.  One only needs to look at Britain’s surprise Brexit vote to understand that these ‘new’ political forces should not be taken lightly. Continue reading

Investing Through Recessions

The U.S. economy has now grown for 69 straight months, making this the sixth-longest period of economic expansion since the 1850s. The stock market has climbed apace—albeit with plenty of volatility along the way.

Still, the law of gravity hasn’t been repealed. Economic growth and contraction have always alternated, and at some point we’ll experience a recession. That, of course, will impact stocks.

Recessions’ Toll on Stocks 

Recessions are defined as periods in which Gross Domestic Product—a measure of trade and industrial activity—shrinks for two successive quarters. Slowing economic activity typically coincides with lower corporate sales, earnings and profit margins, higher unemployment, as well as higher levels of bankruptcy. Typically, equity indexes will fall in advance of and during a recession. Often a bear market, a period when stock prices drop by at least 20%, and a recession, will overlap one another. Continue reading

Quality Bonds: an Underappreciated Role in Portfolios

Stock markets across the globe fell sharply during the first few weeks of 2016. After years of strong stock market performance, downturns like these remind investors of the importance of diversification and disciplined portfolio construction. Even though interest rates remain near historic lows, bonds remain an important part of this diversification as adding them to portfolios lowers volatility (i.e. risk). Historically, high quality bonds, that is those with lesser credit risk, proved an important source of diversification during periods of equity market stress, offering lower correlation while their lower quality brethren tend to have returns more highly correlated to stock market returns. Lower quality bonds imply greater credit risk, which is the risk of not getting paid because the issuer goes bankrupt.

Whenever the outlook for the stock market is threatened, investors will sell risky assets to buy safe investments. This ‘flight to quality’ behavior is a well-known herding reaction to bad news. Historically, owning high quality bonds provides a diversification boost during periods when portfolios need it most. At Crestwood, we include high quality bonds in portfolios to provide a ballast against equity risk which helps to offset periods of stock market stress.

Despite these attractive qualities, concerns over lower expected returns and potential interest rate increases have reduced the appeal for quality bonds. Unfortunately, the near historically low current yields for bonds is suggestive of low future returns (see Perspectives 5/1/15). In addition, the Federal Reserve is on a path to reduce their aggressively stimulative policy of near-zero interest rates. In December 2015, they increased the federal funds rate for the first time since 2006. When interest rates rise, bond prices fall, because most bonds have fixed interest payments and higher rates make these fixed interest payments less valuable. So, not only are lower returns expected, but depending on the pace of future increases in interest rates, it is possible that returns for some bonds could be negative. Continue reading

Profiting from an Emotional Market

The human race’s evolutionary wiring is a marvel: it has enabled us to avoid predators, feed ourselves and thrive in even the least hospitable parts of the planet. Unfortunately, the same wiring has made humans struggle as investors. Following age-old impulses of fear and greed, our species consistently behaves in a manner that often reduces our investment returns.

Ironically, our tendency to commit behavioral errors provides opportunity for disciplined investors to perform better and helps to inform Crestwood’s investment process. Crestwood’s investment process seeks to outperform the market over a full market cycle – with less volatility – by understating, and avoiding, common behavioral errors in the market. Indeed, our investment approach is designed to take advantage of the predictable, self-defeating behaviors of so many market participants.

Behavioral Finance 

Let’s look at a small sampling of the many innate hurdles to successful investing that typical investors must contend with:

Overconfidence: Investors systemically overestimate their knowledge and their ability, and the results can be unpleasant. In 2014, the S&P 500 index returned 13.7%–but the average equity mutual fund investor earned just 5.5%, according to research firm Dalbar. The discrepancy is explained by investors’ well-documented tendency to sell low and buy high. Additionally, high rates of “turnover”—holding investments for a short time, and then dumping them to buy others—demonstrates overconfidence that one investor knows more than others, even though historically low-turnover portfolios have outperformed high-turnover portfolios.

Continue reading

The Case For Owning International Stocks

Recent headlines from overseas have been grim: Debt-wracked Greece is struggling to avoid economic collapse, while slowing growth and rampant speculation has triggered a plunge in China’s stock markets.

For many, the bad news will reinforce a perception that investing beyond our shores is to be avoided. The fact that the S&P 500 has beaten international stocks since bottom of the market in 2009 seems only to reinforce the argument for keeping one’s money home.

Annualized Stock Returns by Region
3/31/2009 to 06/30/15
S&P 500                             20.2%
International Developed       13.3%
Emerging Markets                13.9%
Source: Crestwood Advisors, FactSet, MSCI and Standard and Poor’s

Continue reading

Life in a Low-Return World

Many believe that we’re living in an environment of perpetually slower economic growth and potentially lower investment returns.

Due to a variety of factors, investment returns may be below what investors might have reasonably expected not long ago. However, investors’ desire for returns hasn’t changed and, as a result, many are grappling with how to achieve higher performance in more modest markets.

“Macro” factors

Investment returns are heavily influenced by “macro” factors, which are more universal than, say, the sales results of a particular company. These “macro” factors may help explain why we may be in an era of lower investment returns. Continue reading

Caution: Diverging Monetary Policies & Volatility Ahead

2014 Wrap up:

While the rapid decline in energy prices dominated headlines as 2014 ended, the U.S. stock market turned in a 6th consecutive year of positive returns with the S&P 500 up 13.7%, outperforming most major international benchmarks. Despite a third consecutive year of double digit returns, there was a defensive tone to U.S. equity returns, as the best performing sectors were utilities and health care, while cyclical sectors like consumer discretionary and industrials trailed. The energy sector was the only group posting negative returns for the year, declining 7.8%.

Driving U.S. equities higher was improving economic growth, something that’s been lacking for some time. U.S. GDP for the 3rd quarter grew 5%, the highest rate in 10 years, and revenue and earnings for the S&P 500 came in at 4% and 8%, respectively. We’ve also seen a meaningful decrease in unemployment, with close to 3 million jobs added last year, bringing unemployment below 6% for the first time since 2008. Continue reading