Market volatility

The Beginning of the End? A Look at October 2018 Market Volatility

Not for the first time, October was a difficult period for the stock market. With the drop seen over this past month, there is increasing fear that this is it—the big one that will take us back to the depths of 2008. Although that level of concern is certainly understandable, a closer look at the real economic and market situation around the world suggests that the volatility we are now seeing (and may well continue to see) is perfectly normal. Over time, this kind of turbulence is why stocks can yield the returns they do.

Still, how do we know whether this decline is normal and whether we’re headed for another 2008? Is there a way to tell?

Is this decline normal?

Let’s start with the easy question first. As of this writing (October 31, 2018), the S&P 500 was down about 7 percent from its peak. It has recovered somewhat from its bottom, when it was down about 10 percent. That seems like a big decline; by recent standards, it is. When we look back further, however, this drawdown remains normal.

Since 1980, for example, declines during a calendar year have ranged between 2 percent and 49 percent, with the average at just more than 14 percent. So, the October declines are well within the normal range. The market could drop another 7 percent (i.e., as much as we have already seen), and we’d still be at the average decline for a typical year.

Another way to answer this question is to see how often a decline of any given size occurs. Markets experience a 10-percent decline every year, on average. Even if things get worse—we are not there yet—this is about the fifth drop we’ve seen in the past five years. In that sense, we are once again right in line with the averages.

Are we headed for another 2008?

These facts are all well and good. Even if things are normal now, however, we need to think about how much worse this situation could get. There are no guarantees, of course. But if we look at past bear markets (defined as declines of 20 percent or more), we can make a few observations.

First, of 10 such events since 1929, 80 percent have occurred during a recession. The U.S. economy, despite some slowing trends, continues to grow; we are not in a recession. A growing economy tends to support market values and limit declines.

Second, 40 percent of past bear markets have come during times of rapidly rising commodity prices (e.g., the 1973 oil embargo). Rising prices tend to choke off economic activity and slam profit margins. Now, we have moderate commodity prices overall, which support economic growth and help profit margins, at least here in the U.S. These moderate prices, generally speaking, are not a problem.

Third, during 40 percent of past bear markets, the Federal Reserve has aggressively raised interest rates. While rates have been rising, they are still very low by historical standards. In fact, they are at the lower end of the range that prevailed from 2008 to 2011, after the crisis. They are also likely to stay low by historical standards for some time. As such, we certainly do not have the conditions that fuel a bear market. Despite the recent increases, low rates continue to benefit the economy, which has supported the market so far and will continue to do so.

Finally, half of the bear markets were born when market values were extreme. Current valuations are high by historical standards but low by the standards of the past five years. As we are seeing, an adjustment to lower valuations is painful. But it also means the risk of a further drop dissipates, which takes us back to the fact that periodic drawdowns are not only necessary but healthy.

Almost all bear markets have more than one of these traits; right now, we have (at most) one and really more like one-half of one. This doesn’t mean that we won’t see further declines. It does suggest that they are less likely—and would probably be short lived.

We can also look at recent history to evaluate how much trouble we might see if the situation were to worsen. Earlier this year, for example, markets pulled back by 10 percent, only to rebound and reach new highs. In early 2016, markets were also down more than 10 percent, only to bounce back to new highs. And we can go back further, to even worse pullbacks. In 2011, when Greece almost declared bankruptcy and broke up the European Union, we saw markets drop 19 percent. In 1998, during the Asian financial crisis, we also saw a pullback of 19 percent. Despite the headlines, our current economic situation is much more like early 2018 and 2016, and it is nowhere near as bad as either 1998 or 2011. Even with those declines, the annual return for each year wasn’t disastrous. In 2011, the market ended flat; in 1998, it gained 27 percent.

What is the outlook for the rest of 2018?

Markets have recovered somewhat from October’s midmonth lows, and the economic fundamentals remain good. While further volatility is possible, based on history, it does not seem likely that we will see a further massive and sustained decline that takes us back to 2008. Worst case, if the Chinese trade confrontation situation gets as bad as the Asian financial crisis or the Greek crisis, we could see additional damage. But we likely won’t see anything worse than what occurred during those pullbacks.

With a growing economy, with strong employment and spending growth, and with moderate oil prices and interest rates, the U.S. is well positioned to ride out any storms—more so, in fact, than we were in 2011. Current conditions look much more like 2016 than 2011. As the island of stability in the world, we are also very attractive to foreign investors, as we can see by the strength of the dollar.

Look beyond the headlines

By understanding the history and economic context of today’s turmoil, it is clear that markets may get worse in the short term. Still, the foundations remain solid, which should lessen the effect and duration of any further damage. Yes, the headlines are very scary, but things aren’t that bad. So, we will be postponing the beginning of the end . . . again.

Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.

 All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.

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Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

© 2018 Commonwealth Financial Network®

2018 economic forecast

2018 Midyear Outlook: Will the Economy and Markets Keep Growing?

After the performance we saw last year, we had high hopes for the economy and markets in 2018, but the first half of the year was disappointing. Expectations softened as the stock market pulled back early in the year, economic growth slowed, and risks—largely in trade—rose. As we hit midyear, though, those initial hopes appear to be more realistic than they were even a month ago.

For example, job growth has accelerated this year, bringing us, more or less, to full employment. And with continued wage income growth and ongoing high confidence, consumers are both able—and willing—to spend. Businesses are confident, too, and business investment is showing signs of accelerating. Meanwhile, tax cuts and fiscal stimulus have taken government from a headwind to a tailwind.

With this foundation, we should see continued growth in the second half, fueled by the following:

  • Employment—which is likely to continue to grow, albeit at a potentially slower pace than in the first half of the year
  • Businesses—which should keep and even increase their investment as capacity utilization rises and labor becomes scarcer
  • Government spending—which should continue to revert to growth now that the tax cuts and spending deal are in place

What does this mean, then, for real economic growth? We can expect to see growth of around 3 percent, with the potential for better results. Assuming consumer spending growth of around 3 percent, business investment growth near 5 percent, and government spending growth around 2 percent, this 3-percent figure appears both reasonable and achievable. Combined with an anticipated inflation level of 2 percent for the year, nominal growth should approach 5 percent.

Opportunities and Risks

As always, there are risks to this outlook—both to the upside and the downside.

Looking at the economy, if wage growth increases, consumer spending power could increase more quickly. If consumer borrowing were to pick up, spending could grow even faster. Business investment could respond to improving demand and rise more than expected. Local and state governments could increase investment and hiring more than expected.

Politics presents the greatest risk on the downside. Here in the U.S., the midterm elections will certainly disrupt the political process. If it appears likely that Democrats will take one or both houses of Congress, it could raise substantial economic uncertainties. In the nearer term, the administration’s trade policies could disrupt supply chains and increase costs, which would have consequences for financial markets. Abroad, risks include North Korea and continued political turmoil in Europe. Any of these could result in systemic damage and create real drag on the U.S. economy and financial markets.

Another major downside risk is rising interest rates. In its most recent press conference, the Federal Reserve (Fed) seemed to declare victory on both employment and inflation, which could mean faster rate increases than previously anticipated. Current expectations are for at least two more increases in 2018, and with long-term rates constrained, we could be at risk for an inverted yield curve, which historically has been a sign of upcoming recession.

Turning to the stock market, the rest of 2018 could be quite exciting, in both a positive and a negative sense. Earnings growth should continue to improve overall on the heels of economic expansion, as companies reap the benefits from the tax cuts. As growth accelerates and risks from Europe and North Korea subside, valuations may rise back to previous highs—or even higher on a positive shift in investor sentiment.

There are certainly risks to the market on the downside, however. Valuations are at or above 2007 levels; in other words, they are at historic highs. Profit margins are also at historic highs, and the tailwinds that got them there are disappearing as interest rates rise and wage growth continues to pick up. That’s not to mention that rising interest rates could make bonds more attractive as an investment, which would also weigh on valuations.

Looking at the past three years, a typical lower-end multiple has been 15x forward earnings. Based on current analyst expectations of $176.52 in S&P 500 earnings for 2019, and using a 15x multiple, the 2018 year-end target for the index would be around 2,650, which represents a decline of about 5 percent from mid-June levels. This is a reasonable downside scenario for the end of the year.

If the economy continues to grow, and businesses continue to operate at very high profitability levels, valuations could rise back to around 17x forward earnings. This reasonable upside scenario would leave the S&P 500 around 3,000 at year-end, an increase of almost 8 percent above current numbers.

 Are Things Looking Up?

This is definitely not a prediction of a flat, boring market. Absent the Fed’s security blanket, the market should be more volatile, and it likely will be. A sell-off at some point in the next six months is very possible, with the rising concerns about trade one potential cause. In addition, as rates rise, investors will likely reassess the attractiveness of U.S. stocks versus fixed income. Meanwhile, accelerating wage growth should have a negative effect on profit margins, even as it boosts the economy as a whole.

While the downside risks are real, the ongoing strength of the U.S. economy should protect us from the worst and even continue to offer some upside. The second half of 2018, therefore, seems likely to provide us with more growth in the real economy and financial markets.

Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.

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Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

© 2018 Commonwealth Financial Network®

Veteran Benefits

A Guide to Federal Veterans Benefits

There are two separate agencies overseen by the U.S. Department of Veterans Affairs (VA): the Veterans Health Administration and the Veterans Benefits Administration. The Veterans Health Administration determines eligibility for medical benefits, while the Veterans Benefits Administration determines eligibility for financial benefits. The agencies operate independently and have separate eligibility criteria for their programs. As such, if you qualify for medical benefits, it does not guarantee that you will qualify for financial benefits.

Eligibility for medical and monetary benefits depends on your discharge status. Generally, a veteran will satisfy the discharge requirement if his or her classification is “honorable” or “general under honorable conditions.” A veteran with a discharge classification of “other than honorable conditions,” “bad conduct,” or “dishonorable” may not be eligible for VA benefits.

Medical benefits

The Veterans Health Administration provides health care for former service members. All veterans are eligible for VA hospital and outpatient care, unless they received a dishonorable discharge from active military service. Congressional funding to the Veterans Health Administration, which changes every year, may affect veteran access to care.

You will be enrolled in one of eight priority groups when you apply for medical benefits. Your assignment to a priority group will be based on several factors, including your service-connected disability rating, status as a combat veteran, and income. Priority Group 1 has the highest priority for enrollment.

Special eligibility for combat veterans. Under the National Defense Authorization Act for Fiscal Year 2008, all veterans who served in a combat theater of operations after November 11, 1998, are entitled to five years of VA health care from the date of separation from military service. Combat veterans are automatically enrolled in Priority Group 6.

Agent Orange exposure. The VA presumes that Agent Orange causes certain cancers (e.g., multiple myeloma) and other diseases (e.g., type 2 diabetes mellitus, ischemic heart disease, and Parkinson’s disease). The full list of diseases presumed to be caused by Agent Orange is available here: www.publichealth.va.gov/exposures/agentorange/conditions/index.asp.

This “presumptive policy” for Agent Orange grants eligibility for medical care to veterans who served in either Vietnam or Korea during certain time periods. If you have a presumptive condition, you do not have to prove a causal connection between your military service and your illness.

For Vietnam, the period begins on January 9, 1962, and ends on May 7, 1975. Service in Vietnam includes duty on a ship that operated on inland waterways. Note, however, that exposure to Agent Orange is not presumed for “Blue Water Veterans” who did not serve aboard ships that operated on inland waterways. For Korea, the period includes service in areas around the Korean demilitarized zone between April 1, 1968, and August 31, 1971.

TRICARE. Active service members, retired service members, qualified family members, and certain survivors can receive health care through the TRICARE plan. Care may be offered through either military or civilian providers depending on your status, the TRICARE option you choose, and the availability of care at military facilities.

Compensation and pension benefits

The Veterans Benefits Administration administers financial programs for eligible veterans. Eligibility largely depends on whether you have a service-connected disability or a nonservice-connected disability.

Service-connected compensation. Service-connected compensation is not a pension benefit; rather, it is disability compensation for injuries or diseases that occurred while on active duty or were made worse by active military service. Essentially, it awards you a certain amount of monthly income to compensate for potential loss of income in the private sector due to a disability, injury, or illness incurred in the service. To qualify, your active-duty discharge must be above the dishonorable level.

Service-connected pension. Veterans and their spouses use two types of service-connected pension benefits to pay for long-term care: (1) Aid and Attendance and (2) Housebound. You must be permanently disabled and confined to your home to be eligible for a Housebound pension. The VA assesses your eligibility for Aid and Attendance based on three criteria: (1) wartime service, (2) declining health, and (3) limited financial resources.

The wartime service requirement is specific to the veteran. You must have at least 90 days of active service, including at least 1 day within a defined wartime period. The VA recognizes the following wartime service periods:

  • World War II: December 7, 1941, to December 31, 1946
  • Korean conflict: June 27, 1950, to January 31, 1955
  • Vietnam era: February 28, 1961, to May 7, 1975 (in country) and August 5, 1964, to May 7, 1975 (generally)
  • Gulf War: August 2, 1990, to a date that will be determined by a future law or a presidential proclamation

The need for health care focuses on the condition of the applicant, not the veteran. For example, a healthy veteran may apply for Aid and Attendance to assist his or her spouse. In some cases, a veteran’s surviving spouse may need a personal care assistant. The VA determines the need for health care based on whether the applicant requires help with at least two of the following activities of daily living: (1) bathing, (2) eating, (3) dressing, (4) using the bathroom, and (5) transferring from a chair or bed. The applicant will also meet the health care requirement if he or she needs skilled nursing care or is legally blind.

The VA will assess income and net worth to determine financial eligibility for Aid and Attendance. It considers all sources, including social security benefits, and deducts household and medical expenses to calculate monthly net income. The net worth will include retirement assets. Different sources cite $80,000 as the maximum net worth you can have to qualify for Aid and Attendance. The VA does not list this amount in its regulations; however, it will look at other factors, such as age, when it assesses net worth and financial eligibility.

Other pension benefits. The VA pension programs benefit veterans who have limited income and, in some cases, health problems unrelated to service. Pension benefits are available to you only if you received a discharge other than dishonorable. Currently, veterans receive three types of pensions: Improved, Old Law, and Section 306. Only the Improved Pension is available to new applicants, however.

You are eligible for Improved Pension benefits if you are 65 and older; served at least 90 days of total active service, 1 day of which was during a wartime period; and have limited income and assets that are not excessive. If you are younger than 65, you may be eligible for Improved Pension benefits if you are permanently and totally disabled.

The amount of Improved Pension benefits you receive depends on your marital status, whether you have dependent children, and whether you are able to care for yourself. Pension benefits are designed to supplement your other sources of income, and the VA pays you the difference between your countable family income and your yearly income limit. Pension benefits are generally paid in 12 equal monthly installments, rounded down to the nearest dollar.

Keep in mind: The VA takes into consideration certain expenses paid by you—such as those related to medical care, education, or the last illness or burial of a dependent—when calculating your countable family income. In addition, some sources of income will not reduce your pension benefit. These include Supplemental Security Income, welfare benefits, and some wages earned by dependent children.

Death pension. A fixed monthly pension is available to qualified survivors of low-income veterans. The monthly benefit amount depends on other sources of income and the number of dependents.

Don’t assume: Apply! Many veterans are not getting benefits because they assume they don’t qualify. No matter your circumstances, it is well worth your while to apply for VA assistance. If your claim is denied, you can appeal the decision and may receive benefits on the second try.

Where to apply

You can apply for federal benefits by going to http://vabenefits.vba.va.gov/vonapp, by calling 800.827.1000, or by visiting your regional Veterans Affairs Office. (Please note: Each state offers Veteran Service Officers who assist with determining eligibility for benefits and the application process. They represent their state’s veterans during the federal and state benefits process.)

Third-party assistance with applications

Applying for benefits can be daunting, and you may find individuals or organizations that charge a fee to advise you on the process. Just remember: only the veteran, an accredited Veterans Service Organization, or an accredited VA attorney may apply for benefits on behalf of a veteran. The rules are strict—no one else can file a claim. Also, neither an accredited VA attorney nor an accredited organization may charge a fee to file an application for veteran benefits.

It’s also important to know that firms unrelated to the VA market financial products to veterans. These products are usually annuities and are sold on the basis that they will facilitate eligibility for benefits. You should discuss the financial product offered with your adviser to determine its tax implications and its impact on your overall financial plan.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

 

© 2018 Commonwealth Financial Network®

Investing during troubled times

Investing in Troubled Times: Navigating North Korea, Harvey, and Irma

Presented by Matthew Lang, Lang Investment Services.  Monument, CO.  Serving Investors for 19 years.

The past few weeks have been unusually turbulent. North Korea has tested what is reportedly a hydrogen bomb and launched a missile over Japan; as a result, the U.S. is openly considering war. Hurricane Harvey has been the most damaging storm ever, devastating both Texas and Louisiana. And now we have Hurricane Irma, the most powerful Atlantic storm in history, approaching Florida. Given these events, there are certain questions that investors should be asking themselves. That is, should we be doing something different? If so, what?

Indeed, these questions do require a response. What that response should be, however, depends on an analysis of what has actually changed in the economy and financial markets as a result of these events. So, to decide what we should be doing, let’s take a look at what those changes have been.

Has there been meaningful change?

Despite recent events, the situation with North Korea has been ongoing for decades—this is just the most recent phase. What has actually changed is not that major. A bigger bomb and somewhat better missiles do not put the U.S. at direct risk. In many ways, and regardless of media coverage, this is just a continuation of where we have been for some time.

As far as hurricanes Harvey and Irma, there certainly have been consequential effects on people’s lives. Bigger picture, though, major storms are a regular feature of American history (just think of Sandy and Katrina). Despite the damage they cause, they do not change the economy in a meaningful way. So as bad as Harvey was, and as bad as Irma may be, at the national level they should not result in significant changes.

And how did the markets—which respond to economic forces rather than human tragedy—react to the North Korean situation and the storms? Just as you might expect, they remained steady. In fact, U.S. markets remain close to their all-time highs, supported by strong economic and earnings growth.

What does the past tell us about the future?

To get an idea of whether the economy is likely to change going forward, we can look at the past to review how previous wars and storms have affected markets. Let’s start with wars.

A war with North Korea would be devastating for South Korea and Asia as a whole, but it would have limited effects here in the U.S. In the past, wars have typically resulted in initial declines in the markets. On average, however, markets were up just three months later. As for ongoing effects on the economy, war has typically boosted economic growth, largely due to increased government spending. We certainly can’t rule out a worse experience this time. But history suggests that, as investors, we have no need to panic just yet.

The same can be said for the effects of natural disasters. Of course, they will be devastating to local residents and economies—Houston will be years recovering from Harvey, as New Orleans was from Katrina. But at the national level, the effects are usually short lived, with an initial decrease in economic growth and employment due to the damage and disruption. This is usually followed by a recovery as the rebuilding process gets underway. In this case, the damage and the recovery period are likely to be longer than usual, with two of the worst storms in history hitting within days of each other. But the basic story should end up being the same. In fact, the recovery in Houston has already started as damage is assessed and repairs begun.

While every war and natural disaster is different, and tragic for those most directly affected, we as a country have gotten to be very good at picking up the pieces and moving on. Remember, the U.S. has actually been at war for more than a decade in Afghanistan, and the economy has continued to grow. Hurricanes Sandy and Katrina were devastating, but we moved on and recovered. As long as the base economy remains sound (which it is), the country and the financial markets remain well positioned to ride out the damage.

Should investors be worried?

I said at the start that recent events require a response, and they do. Please consider donating to the victims of the storms, and prepare yourself mentally for more worries from the North Korean situation. You should expect dramatic coverage of all this from the media. You should not, however, confuse emotional responses with what you should be doing with your investments.

Despite the very real problems created by the geopolitical situation and the hurricanes, the U.S. economy and financial markets remain in solid condition and are likely to stay that way. There will be a time and a reason for worrying about our investments. But what we have right now does not meet those conditions. Let’s respond in a way that addresses the real problem, rather than being tricked into doing something we will later regret.

Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

Authored by Brad McMillan, CFA®, CAIA, MAI, chief investment officer at Commonwealth Financial Network.

© 2017 Commonwealth Financial Network®