The sharp 10% correction in stocks earlier in the year seems like a distant memory. Domestic equity markets regained new highs in the third quarter as the ongoing narratives surrounding shaky emerging markets, never-ending Brexit negotiations, rising interest rates, and trade tensions failed to dent confidence. It’s enough to keep cautious investors questioning if we are closer to the end of this decade-long bull run.
Despite these headwinds, confidence in the economy continues as job growth and economic activity move along. Corporate earnings continue to exceed already lofty expectations, helping support equity valuations. Global stocks pushed higher in the third quarter. Stabilization of the US Dollar and reduced uncertainty on the trade front helped global stocks add 4.3% in Q3.
The bond market continues to feel the drag of higher interest rates, hampering near-term price performance. The steady flattening of the yield curve has stalled for longer-dated maturities – a potential sign bond vigilantes are crying uncle to the Fed.
Sticking with International
International markets are a drag on global stock markets this year. But we are reminded that effective diversification often means that, at any given time, there will be a part of your portfolio you will likely despise.
Investors still benefit from an internationally diversified strategy. While international stocks will suffer from the same ups and downs as shares in US-based companies, broad global exposure protects long-term stock investors from long, drawn-out bear markets that are primarily driven by a country’s economic performance. Additionally, while a US domestic investor gains some international exposure through US-based multinational companies, this investor still misses out on significant economic and market forces that could generate return for shareholders. Many international firms also sell into the US. A purely domestic investor misses some import-led domestic growth opportunities as well as certain global market opportunities. Valuations for many international stocks are also more attractive, suggesting investor sentiment is currently down on these sectors of the market. Over time sentiment ebbs and flows, benefitting those patient enough to ride out the lows.
Market strategists spin stories about why US stocks have outperformed this year, but this is little help as a guide for what may come. A broad, well-diversified strategy provides discipline and the stability to stick to long-term goals.
When It’s Too Good to be True
It’s not easy to identify financial scams. Scam peddlers are often well-rehearsed, sometimes with polished primetime television commercials, as in the recent case of a Knoxville-based financial salesperson promoting high-yielding, investment notes with 10% returns and an average term of nine months.
Unfortunately, it appears to be fraudulent. The Securities and Exchange Commission and the U.S. Attorney's office are investigating an alleged $283 million loan fraud that was sold through a network of unregistered brokers and financial advisors. On July 27, two lenders to small businesses, 1 Global Capital and 1 West Capital, filed for Chapter 11 bankruptcy in U.S. Bankruptcy Court for the Southern District of Florida.[i]
According to information in the bankruptcy filings and recent reports in the financial news, the local broker/advisor placed approximately $53 million with these now insolvent entities and collected almost $1 million in commissions the last four months of the scheme.[ii]
Fraud is a cancer on the investment industry, preying on the greedy, the overly-trusting, or the ill-informed. The saying goes, if it sounds too good to be true, it probably is. The tricky part is identifying what sounds too good. We think it’s helpful to always be on the lookout for the warning signs of potential fraud.
Always invert. Just as you want to earn the best return on your money, a business owner wants to finance his or her operations at the lowest possible cost. That typically means seeking funds from friends and family, banks and other professional investors specializing in private investments before turning to individual investors. It’s always helpful to ask: who has passed up this opportunity? Are there good reasons for seeking funds outside traditional banking and private financing channels? Occasionally there may be, and it’s worth understanding why.
Guarantees are a bad sign. All investments have the potential to lose money. A fundamental law of investing is return is the reward for taking risk. If there is no risk, then the returns shouldn’t be much more than what your money can earn in a bank. In the financial world, nothing is risk-free. In fact, the mere mention of a “guarantee” is a likely warning sign.
Have a good baseline. A good perspective on financial markets – both the historical record and reasonable expectations for broad asset classes – can also help raise red flags. Investments with similar types of risk should yield a similar return. It’s reasonable to expect that two AA- rated corporate bonds maturing in five years should have about the same return. Of course, actual returns can be very different if one company reports good results and the other languishes. But the promise of unusually high returns at the outset compared to other comparable investments is a sign to tread cautiously. Someone claiming a 10% return on nine-month loan is “safe” in the current low interest rate environment should set off a host of alarms.
What’s in it for you? Too many representatives in the financial services industry are heavily compensated to sell products or place deals. It’s always worth asking how the advice-giver is compensated, allowing you to identify potential conflicts of interest. If the sales incentives seem too high, that is yet another reason to worry. If you are wondering, $1 million in four months is.
Asking the right questions can help spot the red flags. Get-rich-quick and Ponzi schemes are as old as civilization and despite regulators best efforts, fraudulent investment opportunities will continue to seek victims hoping to make out before anyone catches on.
What It All Means
The fourth quarter is shaping up for more drama. A heated midterm election will be heavily in focus as Republicans fight to control Congress. Italy’s deficit-expanding budget proposal threatens another showdown with their northern European counterparts. A sigh of relief was felt in markets as trade negotiators reached an agreement to modify NAFTA, avoiding a complete fallout as some feared. But a deal seems far from certain with China as divisions runs much deeper. Still, markets have a long and deep history of working through these uncertainties.
Always remain vigilant. A healthy dose of skepticism is a valuable asset when considering new investment pitches. That goes for legitimate and illegitimate strategies alike. Of course, working with trusted advisors can also help evaluate any potential opportunities.
Please contact us if you would like to discuss your financial plan or your investment strategy.
Contact us at 865-584-1850 or firstname.lastname@example.org
DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Proffitt & Goodson, Inc. makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. The information is subject to change and, although based on information that Proffitt & Goodson, Inc. considers reliable, it is not guaranteed as to accuracy or completeness. Source information is obtained from independent financial data suppliers (Interactive Data Corporation, Morningstar, etc.). The Market Categories illustrated in this Financial Market Summary are indexes of specific equity, fixed income or other categories. An index is a reflection of the underlying securities in a particular selection of securities picked due to a particular type of investment. These indexes account for the reinvestment of dividends and other income, but do not account for any transaction, custody, tax, or management fees encountered in real life. To that extent, these index numbers are artificial and cannot be duplicated in real life due to the necessity of paying those transaction, custody, tax, and management fees. Industry and specific sector returns (technology, utilities, etc.) do not account for the reinvestment of dividends or other income. Future events will cause these historical rates of return to be different in the future with the potential for loss as well as profit. Specific indexes may change their definition of particular security types included over time. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of Proffitt & Goodson, Inc. Past performance does not guarantee future results.