Stock markets added to their strong year-to-date performance in July. The S&P 500 rose for the 4th straight month, touching new highs again. Stock markets outside the US outperformed domestic markets in July, helped largely by a declining dollar.
Bond markets were relatively quiet despite several central bank statements suggesting tighter global monetary policy is likely later this year. The yield curve steepened and inflation expectations improved as oil prices gained over 9% in July. Investment grade corporate bond yield spreads over Treasuries tightened, coming within five basis points of 10-year lows.
The decline in the US dollar was at the center of most market moves in July. The greenback fell 3.5% versus the Euro. As noted last month, the dollar is the first major asset to give back its post-election gains. Not all of this move should be attributed to a ratcheting down of policy expectations in Washington. Core inflation has softened recently, relieving some pressure from the Fed to hike rates again. Some of the decline can also be attributed to better growth and the prospect of higher interest rates elsewhere in the world as global economic activity measures have improved. European Central Bank Governor Mario Draghi recently declared that the “threat of deflation is gone and reflationary forces are at play.” If economies outside our borders are turning a corner, the dollar may continue its retreat.
The news out of Washington isn’t getting any better. Any hope of tax reform was called into question as Republicans failed to reform healthcare. Rhetoric towards North Korea is slowly intensifying. Recent turnover of the chief of staff, press secretary and communications director suggest the White House is far from a well-oiled machine. Outside the fall in the dollar, financial markets have largely ignored all this as stocks have reached new highs.
While the chaos in the executive branch is concerning, there are few signs of a spillover into the economy. Job numbers suggest we are still in the midst of expansion, corporate earnings are up over 10% in Q2, beating expectations, and inflation remains under control. So even as the Russia investigation expands, legislation may get sidelined further, reducing policy uncertainty that markets tend to dislike. While we shouldn’t write off any chance of volatility from a constitutional crisis or military action against North Korea, the underlying health of the economy should provide support against any shock to investor confidence.
Setting Up for Success
We discussed last month about the importance of establishing an investment philosophy and embracing overarching principles that should serve as a guidepost. The next step is to identify goals for your financial future. For most people this boils down to: “How much money will I need during my life, and what do I want to do with my money when I am gone?”
There are many considerations that determine what you’ll personally need and what income sources you’ll have. Health care concerns, end-of-life care, travel, current and future taxes and inflation are big factors in addition to basic living expenses. Considering a cushion for unexpected expenses such as home repairs or out-of-pocket medical expenses is also a good idea. If you carry a policy, life insurance can have a part in this as well. Social security may be a partial source of income in retirement but will probably not exist in its current form for many young people in the work force today. For most individuals, investment accounts will be the primary source of liquidity in retirement. Careful thought to how much you may need to support a comfortable retirement is a crucial part of investing.
For many, this planning goes beyond personal needs to considering leaving money for family or charities. Many people want to leave money for future generations, but don’t want to spoil their kids and grandchildren. So, it is important to think about how this transfer may be structured. Philanthropic goals may also warrant consideration as a result of personal values and beliefs. These considerations for your wealth typically involve extending the useful life of your money beyond your lifetime and are important when considering how your money should be invested.
It’s okay if your goals shift over time. The idea is to generate reasonable working assumptions about what retirement will look like, not strike a tight, unwavering budget. For many, this planning is an iterative process and often goals and priorities change as family situations do. Still, an imperfect idea of what you want is better than no strategy at all.
Your Personal Pension Plan
After you’ve got a handle on what you’ll need in retirement, you’ll want to assess if your asset base can sustain all of the goals. This process is akin to a traditional corporate pension plan; estimate future expenditures and solve for the return required to meet those expenses. A reasonable required rate of return should be in line with what can be earned in the bank or the stock and bond markets. If it is greater than what can be earned in the financial markets, then you may be setting yourself up for disappointment and potential hardship down the road.
Assessing your portfolio this way can be more informative than simply devising a simple spending rule. This process is more flexible and can help answer important questions such as: should I save more now? Should I stop working when I want to? How much of my portfolio will I need to drawdown?
Deriving a required return for your money allows investment risk to be tailored specifically towards your goals. The investment volatility, while important, is a by-product of investing to meet your objectives. It’s also helpful for assessing the performance of your portfolio along the way. Measuring the performance of your portfolio against a required return helps to hold your advisor and yourself accountable for meeting your objectives.
But even if your plan seems feasible given reasonable financial market assumptions, there are other considerations. Beneath that return target may be a list of priorities as well. Perhaps maintaining a certain lifestyle comes first, then legacy gifting, and finally some luxury travel. Identifying your needs and prioritizing the uses of your wealth create a foundation for devising an asset allocation. Understanding what’s important to you ultimately drives how your money is invested and what risks are worth taking.
What It All Means
Moves in the US Dollar can have big impacts across the globe. A depreciating dollar relieves the pressure on foreign companies to service their USD-denominated debt. It also boosts competitiveness of exporting companies while increasing the costs for imports, leading to greater export-driven growth at the margin. It can also make your European vacation a bit more expensive, and increase gas prices too. For our investment portfolios, we have long believed that international diversification can smooth the impact of currency moves and improve the exposure to global earnings growth.
Having a grasp on what your portfolio is supposed to do for you can help gain perspective on short-term market moves. A well-crafted investment plan should immunize your lifestyle from ups and downs in the market as well as keep a focus on meeting longer-term goals. It’s an important step in developing a portfolio that helps you sleep at night.
As always, please contact us with individual questions or concerns.
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