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AN UPDATE ON RELEVANT THEMES

Risky asset prices have recovered from the vicious 4th quarter 2018. Headlines matter again. The Federal Reserve’s policy decisions in early 2019 gave investors the green light to speculate. Most of the near-term risks remain geopolitical including Trump’s trade war with China. With this as the backdrop, now is a good time to revisit the themes that have us thinking differently.

Rise of the Machines

  • Computer-based algorithmic trading now dominates trading in many asset classes. Speed matters. In stable markets, there is plenty of liquidity. However, when the tide turns and volatility rears its ugly head, liquidity may disappear.
  • Sell-offs are amplified with prices overreacting. These can be sudden, gut wrenching and leave investors scratching their heads (think December 2018).
  • Investors need to stomach the instability and stick to their long-term plan. Include strategies to protect against this risk and be prepared to take advantage of opportunities caused by volatile markets.

Lower for Longer

  • After a financial crisis like that experienced in 2008, the recovery is not as robust and takes longer than the typical post-recession recovery.
  • Economic growth, interest rates and inflation will continue to remain below trend. This was reinforced this year by the Federal Reserve’s decision to pivot and not hike interest rates.
  • Income based assets remain important for the safety and stability they provide to a portfolio, yet they generate less income than in the past.
  • Producing portfolio income remains challenging. Investors need to limit chasing yields in riskier income strategies.

Secular Disruption

  • New competitive forces, combined with changes in technology and consumer habits, are disrupting incumbent industries and businesses at an accelerating pace (i.e. the “Amazon effect”). Navigating the new environment is crucial to success.
  • Considerable time and effort will need to be devoted to research and analysis. Access to industry and company specific expertise are even more important due to the rapidly changing landscape.
  • The days of buying a stock and holding them for the long-run may not work as well as it did in the past.
  • The “do it yourself” investor who likes to pick stocks needs to realistically evaluate his or her ability to compete in this environment.

Valuations

  • The valuations for many asset classes are expensive based on historical measures. For example, on a price to earnings basis, US stocks have been cheaper more than 75% of the time vs. today’s levels. (1)
  • With valuations above average, it is unlikely that US stocks over the next 10 years will produce the double-digit annualized returns that they have over the past 10 years.
  • Valuations are not a near-term market-timing tool. Investors should however lower their projected return expectations from a diversified portfolio going forward.

(1) Valuation commentary on US stocks is based on cyclically adjusted price to earnings data from Robert Shiller http://www.econ.yale.edu/~shiller/data.htm