Is There a “New Normal”?

Some years ago, Mohamed El-Erian, then chief strategist at Pimco Asset Management, dubbed this now commonly used phrase to describe economic growth that is less than that of historical norms. This is not without controversy, as any claims that sound like “it’s different this time” is nearly blasphemous to most investment professionals, trained to expect and position portfolios for “reversion to the mean.”

If such a “new normal” exists, what does it mean and why does it matter? Do we, at Fundamentum, subscribe to this theory and if so, what are the implications?

First, we would suggest the “new normal” incorporates most basic economic conditions. Most important to us include:

  • GDP growth rates
  • Levels of inflation, and the
  • “Equilibrium” Fed Funds rates.

Today, despite full employment and healthy economic growth both here and abroad, and with the USD declining over the course of the year, measures of inflation remain stubbornly below the Fed’s desired 2% level and have, for some time.

Is this an example of the new normal?

Similarly, although the most recent quarter showed Real GDP growth of 3%, the U.S. economy has been stuck in the 2% range for some time, despite massive amounts of liquidity injected into the banking system by the Federal Reserve ($3.5T since 2008), near-zero percent interest rates for over eight years, and every economy measured by the IMF is registering positive economic growth for the first time in nearly 30 years.

Is this an example of the new normal?

Another example of what might be this new normal is the Yield Curve. While the yield curve (2/10 year is most of interest) is still upward sloping at ~77bps, and not indicative of near-term recessionary conditions, it surely doesn’t register on the “long end” levels that are historically associated with solid economic growth, full employment and rising commodity costs in certain areas (copper, steel, aluminum, iron ore).

Surely, this must be an example of the new normal at work.

At Fundamentum, we continue to believe in the laws of economics. Supply and demand WILL dictate price levels in the future, as they have in the past. Said simply, there WILL continue to be cycles, even in a new normal environment.

As the Federal Reserve Bank of San Francisco pointed out in a recent white paper, there is now strong evidence to support the notion of new normal economic environment.

Consider an excerpt from the San Francisco Federal Reserve, written the fall of 2016….

Estimates suggest the new normal for U.S. GDP growth has dropped to between 1½ and 1¾%, noticeably slower than the typical postwar pace. The slowdown stems mainly from demographics and educational attainment. As baby boomers retire, employment growth shrinks. And educational attainment of the workforce has plateaued, reducing its contribution to productivity growth through labor quality. The GDP growth forecast assumes that, apart from these effects, the modest productivity growth is relatively “normal”—in line with its pace for most of the period since 1973….

It is a fact that in the U.S., labor markets are not growing at the pace of the post-war era. In addition, productivity remains stuck at historically low rates of growth, something we believe, can, and will, revert to the mean, especially with the implementation of business-friendly fiscal policy. Still, with one of the two main building blocks (labor market growth) expected to remain depressed for some time, it is difficult to NOT accept the premise of a new normal economic condition.

The Investment Committee at Fundamentum has attempted to identify other factors in addition to demographics that argue for a new normal. While not tested, or proven, these are in the narrative of most economic and business writers we read and are well-accepted by most:

1. China – While China remains an important engine of growth for the world economy, it’s impressive high-single digit rate of economic growth is roughly half that of the 1990-2012 period. Now the second largest economy, this diminished rate of change lowers the potential for world GDP growth.

2. The Internet – the internet imposes a price discovery mechanism that wasn’t available in most post-war periods. This has important implications for pricing for many items that would tend to depress the historic inflation rates.

3. Globalization – certainly globalization, or the ability to offshore production to lower-cost regions – was not the factor in much of the post-war periods. This too, has important implications for pricing power and the levels of wage inflation today, versus the past.

Our conclusion is that there are strong reasons to expect a new normal for economic growth and inflation rates in the foreseeable future. Still, we want to be clear that this does NOT make laws of economics less applicable.

There will still be cycles but compare to the past, perhaps the amplitude won’t likely be what they have historically been. This has direct implications for the level of the equilibrium Fed Funds rate (lower), inflation (lower) and GDP growth (lower).

Perhaps the dampening of inflation (and interest rate) cycles will have positive implications for valuation levels for equities, as today’s somewhat elevated valuation levels may not be the impediment to future returns that most observers (including ourselves) think they will be, if the magnitude of the inflation cycle is lowered. Perhaps this offsets the less-than-normal rates of return from fixed income vehicles, supporting our tactical position of favoriting equities over fixed income.

Evidence of a new normal also factors into our belief that 10-year expected returns for both stocks and bonds are lower today compared to most 10-year look-back periods historically. This is important for financial planning exercises.

Here’s another excerpt from the San Francisco Federal Reserve on their conclusions regarding the evidence of a “new normal” ….

This lower pace of growth has numerous implications. For workers, it means slow growth in average wages and living standards. For businesses, it implies relatively modest growth in sales. For policymakers, it suggests a low “speed limit” for the economy and relatively modest growth in tax revenues. It also suggests a lower equilibrium or neutral rate of interest. Is the new normal a bad thing? We don’t necessarily believe that it is, but it must be understood to prevent policy mistakes or for political parties to be aiming for objectives based on past conditions that aren’t likely to be met in the future. We certainly can’t change the factors that have led to a new normal, but recognition of them can assist us in positioning our client portfolios for realistic returns and in meeting expectations, which is surely a hallmark of successful wealth management.

Paul Danes, CFA
Fundamentum Investment Committee November 1, 2017


Chad Roope, CFA – PORTFOLIO MANAGER
Paul Danes, CFA – INVESTMENT COMMITTEE
Daniel Jacoby – CHIEF INVESTMENT OFFICER
Trevor Forbes – CEO AND HEAD OF INVESTMENTS, RENAISSANCE INVESTMENT GROUP
Matt Dunn – Chief Compliance Officer
 
Our Internal Investment Management Division
• Deliver institutional quality, reliable portfolio solutions that fit many needs in the financial planning process
• Competitive Pricing: 29 basis points or less
• Dedicated team of Investment Professionals located in Cleveland, Ohio
• Collective experience of ~100 years, managing ~$40B of AUM
• CFA Charterholders
• Dedicated team of support staff including operations, trading and marketing
• Full access to the Portfolio Management Team for consultation and client presentations
• Over 20 portfolios in 5 distinct investment sleeves, focused on Tactical Asset Allocation portfolios, utilizing ETFs, Index Funds, individual securities and actively managed funds.

The Fear of Missing Out…

Stratos Wealth Partners

If you have teenagers, you are undoubtedly aware of this social media-driven phenomenon, (dare I say curse) that most teenagers have regarding “Fear of Missing Out.” It’s certainly a big reason most are glued to smart-phones nearly 24/7 as they stay connected to the pictures and stories posted by their friends (and it’s Snapchat, NOT Facebook for those keeping score at home).

I believe we’ve entered a phase in the market cycle where this psychological factor is growing in importance to many investors. Q3 earnings results for many of the large-cap Tech bellwethers and the incredible reactions their stocks enjoyed must have weighed on the psychology of the investor who might be “out of the market.”

Imagine the pressure an investor feels (or advisor, fund manager) who has missed this terrific year of equity market returns (and bonds and gold and real estate returns) as they were afraid of high valuations, afraid of Trump, of hurricanes, of North Korea, of rising interest rates and all the other reasons many commentators have offered for why this is a dangerous time to own risk assets. We know that while equity-oriented ETFs continue to enjoy strong inflows ($780B since 2009), there’s has been a net OUTFLOW of equity-market mutual funds ($973B over that same period) making this one of most hated bull markets in history. Corporate buybacks is the missing link for the mismatch of supply/demand.

We have now passed the most dangerous months for equities historically and markets tend to rally into the year-end, especially in years when the 10-month rise has been as strong as 2017’s performance. We must consider the implications of what many describe as the “melt-up” stage of the equity market cycle, where investors throw caution to the wind and “chase” returns into the New Year.


This behavior would not surprise us and it can be a very lucrative time to be fully invested. You don’t want to miss this stage as many professional managers did later in the dot.com cycle when many couldn’t stomach those high valuations.


Recall that markets rallied for THREE YEARS following Greenspan’s famous “irrational exuberance” statement made in December of 19961. Many famous investors and funds so badly lagged the returns of the S&P 500 in 1998 and 1999 that some lost their business, closed their funds and many hedge funds returned cash back to their investors.

Of course, these same managers were vindicated when the bubble burst following the peak in the spring of 2000 but many were also out of business!

Personally, I was co-managing a large-cap, domestic mutual fund and institutional accounts for an asset management firm and while we too lagged the S&P in those melt-up years, I was lucky to be partnered with a more technically-inclined colleague who kept us “in the market” for longer than I would have if acting alone. We lagged, but we “participated” and few (if any) clients fired us for being within 2-3% of market returns.


The point here is that while “melt-ups” feel great and you don’t want to miss them,
you must also be prudent and take some chips off the table on the way up. 

“It is nearly impossible to time the top.”


At Fundamentum, while we have taken some chips off the table by dialing back small-cap domestic equities and high-yield bonds early on in 2017, we have largely held the course and in our Tactical portfolios, we have been rewarded by strong absolute returns and out-performance versus our benchmarks for the most part.

Our Investment Committee meets every week, pouring over the economic data, valuation data, technical data, and truth be told, we are looking for reasons to pare back risks more, but have resisted for the most part beyond the measures already mentioned. Surprising to some of us (me), this aging economic cycle appears to be gaining steam globally, and doing so without generating much inflation pressures (so far). Valuations are high but nowhere near the levels of 2000.

It was recently pointed out by Professor Robert Schiller that his “CAPE” ratio2 is now at the same level as it was at the time of Greenspan’s irrational exuberance statement in 1996. Tech stocks, for instance, currently sell at high levels relative to their 200 day moving averages (+15%), but this compares to nearly 50% above their moving averages before the bubble burst in 20003. Equities markets that are overly concentrated and expensive, as they were in the spring of 2000 are clear warning signs. Today, while the largest FIFTY names in the S&P 500 Index sell for 18x forward earnings estimates, they sold for 31x forward earnings in March of 2000. Regarding concentration, the TEN largest holdings in the S&P 500 Index make up 20% of the Index, up only a few points from the 18% lows, compared to the highly concentrated 27% in 2000.

Don’t misunderstand, we know it’s dangerous to attempt to ride relatively expensive markets higher, especially with interest rates and inflation rates likely moving higher.

We get MOST EXCITED about the prospects for equity returns when valuations are low (NOT), when inflation is high and falling (NOT), when interest rates are high and falling (NOT) and when margins, earnings and sentiment are depressed (NOT). Clearly, that is not the environment we are in today.

It’s hard to say whether today, November 1, 2017 most resembles 1996, 1997, 1998, 1999, or 2000, but we feel reasonably good about the economic prospects for the next 6-12 months (with or without tax cuts) and signs of a recession are slim. We are monitoring the yield curve but even here, at today’s level of 75bps (10-year vs. the 2-year), the last four times we are at similar stages, it took 12 months, 8 months, 31 months and 12 months before inverting which is a dangerous time to own equities. It appears we have time.

In conclusion, like many, we are “nervous bulls” for the short term and remain convinced that LONG-TERM equity and fixed income returns are likely to be subpar as the starting point matters most for long-term returns (not so much in explaining SHORT-TERM returns).

Today, at 18x and 2.40% on 10- year Treasuries, we believe these levels represent headwinds for long-term returns, but not so extreme to prevent further appreciation in the short-term.


If a melt-up occurs, enjoy it but be aware that they generally end badly
and be prepared to adjust.
Your Fundamentum Investment Committee endeavors to do the same.


Paul Danes, CFA
Fundamentum Investment Committee November 1, 2017


Chad Roope, CFA – PORTFOLIO MANAGER
Paul Danes, CFA – INVESTMENT COMMITTEE
Daniel Jacoby – CHIEF INVESTMENT OFFICER
Trevor Forbes – CEO AND HEAD OF INVESTMENTS, RENAISSANCE INVESTMENT GROUP

Our Internal Investment Management Division
• Deliver institutional quality, reliable portfolio solutions that fit many needs in the financial planning process
• Competitive Pricing: 29 basis points or less
• Dedicated team of Investment Professionals located in Cleveland, Ohio
• Collective experience of ~100 years, managing ~$40B of AUM
• CFA Charterholders
• Dedicated team of support staff including operations, trading and marketing
• Full access to the Portfolio Management Team for consultation and client presentations
• Over 20 portfolios in 5 distinct investment sleeves, focused on Tactical Asset Allocation portfolios, utilizing ETFs, Index Funds, individual securities and actively managed funds.
1 standardandpoors.com
2 econ.yale.edu
3 Strategies Research Partners MorningstarDirect.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Investing involves risk including loss of principal.
Investment advice offered through Fundamentum, LLC., a registered investment advisor.

Fintech Deployment Woes? Call In the ‘New Gatekeeper’ Team

The choice of technology solution — whether for CRM, planning or practice management — is often fraught with peril

Who are the key stakeholders in determining the technology a firm utilizes, and what impact do the tools an advisor uses have on end client engagement?

These questions were at the heart of the panel discussion “Technology, Financial Services and the New Gatekeepers” held Monday at the T3 conference in Las Vegas, with a panel including Jeffrey Concepcion, founder and CEO of super OSJ Stratos Wealth Partners, and Steven Wallman, founder and CEO of Foliofn, best known for services including Folio Investing and the SRI Conference.

As advisory firms grapple with disruptive technologies such as robo-advice platforms, not knowing whether to embrace or differentiate from a growing array of self-service tools flooding the marketplace, Concepcion suggested that successful firms will become “bionic advisors,” leveraging innovative technologies where needed, especially for the increasingly millennial audience that won’t be bothered with the time it takes to interact with a live advisor.

The choice of technology solution — whether for CRM, planning, or practice management — is often fraught with peril. Panel moderator Matt Lynch, managing partner of the consulting firm Strategy & Resources, said that as a rule, six months after a tech rollout at an advisor firm, the new technology has a negative Net Promoter Score (NPS), meaning most users dislike the new tools.

An FPA survey found that less than a third of advisors were fully prepared to manage the risks of a…

Firm like Stratos are adopting the “new gatekeeper” role, developing a staff of experts whose role is assisting in matching technology providers to advisory firms, with the goal of enabling better decision-making when it comes to applied technology throughout the practice. This enhances technology adoption in several dimensions, including facilitating build-or-buy decisions and providing guidance in modifying commercial off-the-shelf software to meet an advisor’s needs without building a solution from scratch.

One sticking point raised during the panel was the lack of a common data language for fintech software and services, which can raise barriers to integration between different offerings. Since most advisory firms rely on a variety of applications and services in their practice, the lack of an industry-specific application program interface (API) puts a greater burden on internal IT, often requiring multiple calls to a vendor’s support staff to achieve the desired integration.

This problem is being addressed by new gatekeeper teams as well. For example, the Stratos team also acts as intermediary between advisory firms and vendors, fielding first-level support calls to further reduce friction between vendor and firm.

As clients increasingly rely on their mobile devices to electronically interact with financial advisors, the mobile user experience increases in importance, and is rapidly becoming a differentiator when advisor services are otherwise roughly equal. To that end, advisory firms of all sizes will need to develop strategies for adopting and integrating new technology as it reaches the market, and may find that relying on a “new gatekeeper” partner can quicken the adoption of the next big thing in fintech, whether AI or support for the latest iPhone.

____

Originally published on ThinkAdvisor. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

Concepcion Interviewed for Financial Advisor IQ

President/CEO, Jeff Concepcion, was interviewed by Financial Advisor IQ reporter, Rachel Monroe, on the topic of how financial advisory firms can scale their practice while avoiding the pitfalls of growing too fast. Stratos provided Financial Advisor IQ with an updated AUM statement and Jeff’s headshot. The article was published in November, 2015.

2015 Weatherhead 100 logo

Stratos Recognized in Weatherhead 100

Stratos Wealth Partners was selected as a 2015 Weatherhead 100 Winner in the category of “Weatherhead 100.” This award recognizes that Stratos is one of the 100 fastest-growing companies in Northeast Ohio.

To be considered for the Weatherhead 100, companies must have net sales of at least $100,000 in year one of five years required for the application and over $1 million in year five. Willing companies must have employed a minimum of 16 people full time in the last year.

Interview with Charles Shapiro and Chris Robbins of Financial Advisor magazine

The interview covered a wide range of topics to include Stratos’ founding, the firm’s growth in the West (San Diego and Arizona), the solution they offer to advisors looking to go independent, Stratos’ target demographic, etc. KCD PR expects the article to run in October.

Finally, Dan Jacoby’s advice on the stock market selloff was featured in an investing section article on Forbes.com.