Fourth Quarter Newsletter
Responsible Guidance: Fourth Quarter 2020 Newsletter, January 2021
I cannot believe that...
2020 was quite a year and we are sure if you discussed different topics, you probably started a sentence with the phrase "I cannot believe that…". In discussions with clients throughout 2020, we heard numerous times some version of "I cannot believe that the market is doing what it is doing".
We have released educational content over the years about how difficult it is to predict market movements, even if you were able to obtain all the news ahead of time. At Baron, we do not try to time the market; we develop customized investment strategies that are diversified and risk- appropriate. These strategies keep clients invested and are more focused on time-in-the-market and rebalancing when needed, versus trying to time the market.
Of course, the time-in-the-market argument sounds great when markets go up unexpectedly, as they did at the end of 2020. We mentioned rebalancing, which is extremely important, especially after major market moves. But there is something else that is also extremely important, and that is the planning process, ahead of any investing, to identify the right strategy for clients. As part of that planning process, we test portfolios in different market environments. This provides some perspective as to what to expect if markets move, not only in positive directions, but also in negative directions. Understanding portfolio impacts and impacts to Your Personal EconomySM in different market environments, helps clients stay calm and stick with their strategy, which was extremely important during March of 2020. So, though it may be difficult to believe what is happening in the markets, you should understand how Your Personal EconomySM may be impacted by market moves, even if they seem unbelievable.
A Global Perspective
A core objective for our customized Baron Financial Group investment strategies is global diversification. Global diversification means including investments based both domestically in the U.S., as well as internationally in developed and developing countries.
There are popular benchmark indexes that provide perspectives about performance of global investments. For equities, we monitor the MSCI ACWI All Cap Index. This index is designed to represent equity investments across 23 developed and 24 emerging markets. The index was up 15.77% in the fourth quarter, as equity performance continued to rebound from the downturn most experienced in March, due to the impacts from the Covid-19 pandemic. Year-to-Date (YTD) the index finished up 16.31%, with performance mostly driven by activity in the fourth quarter. For fixed income, or bonds, we track the FTSE World Government Bond Index. The index tracks sovereign debt from 20 countries, denominated in their respective currencies. It was up 2.77% in the fourth quarter and performance finished the year up 10.11%, as high-quality fixed income investments have performed well across the globe.
The economic picture remains cloudy as we work through the issues related to the pandemic. We did see a nice turnaround in economic growth during the third quarter, but a resurgence of cases has reignited concerns and has some areas of the country reverting to slowing or shutting down business activities. Hope remains for the distributions of vaccines.
The Bureau of Economic Analysis (BEA) announced in its third estimate for the third quarter of 2020 that real Gross Domestic Product (GDP) increased 33.4%, which was a substantial turnaround from the second quarter decrease of 31.4%. After experiencing economic shutdowns in the second quarter due to the Coronavirus, consumer spending, private-inventory investment, exports, nonresidential-fixed investment, and residential-fixed investment all added positively to GDP. Offsetting factors included decreases in federal, state, and local government spending. Also, impacts from imports were a drag on the third quarter.
The BEA did release a technical note related to third quarter GDP, which can be found on their website at www.bea.gov. “The increase in third quarter GDP reflected continued efforts to reopen businesses and resume activities that were postponed or restricted due to COVID-19. The full economic effects of the COVID-19 pandemic cannot be quantified in the GDP estimate for the third quarter of 2020 because the impacts are generally embedded in source data and cannot be separately identified.”
GDP is a measurement of what has already happened. There are, however, statistical measures that give insight into the future. One of those measures is The Conference Board Leading Economic Index® (LEI) for the U.S. The index is an analytical tool that helps signal peaks and troughs in the business cycle. The November LEI, released on December 18th, improved to 109.1 (2016 = 100), following increased readings in September and October.
“The US LEI continued rising in November, but its pace of improvement has been decelerating in recent months, suggesting a significant moderation in growth as the US economy heads into 2021.”, said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Initial claims for unemployment insurance, new orders for manufacturing, residential construction permits, and stock prices made the largest positive contributions to the LEI. However, falling average working hours in manufacturing and consumers’ worsening outlook underscore the downside risks to growth from a second wave of COVID-19 and high unemployment.”
We think the following chart is an important tool to help potentially signal changing economic environments, such as recessions. The blue line represents the LEI, dating back to the year 2000. Since then, we have had two official recessions, which are identified by the shaded gray areas. A recession is typically defined as two consecutive quarters of negative economic growth. Using the last two recessions as a gauge, we believe that the chart suggests that there was significant erosion in the LEI (blue line moved lower) prior to the economy going into recession. Of course, in 2020, the shutting down of economies to help slow the spread of the virus lead to violent changes in economic numbers. Though we did not have 2 quarters of negative growth, we think it is safe to say the U.S. economic environment is experiencing challenges. There was a quick rebound in the third quarter, but the comments from Ozyildirim suggest challenges remained during the fourth quarter of 2020.
According to the Bureau of Labor Statistics (BLS), the U.S. lost 140,000 jobs for the month of December, though the unemployment rate remained steady at 6.7%. BLS suggest the decrease resulted from impacts from the Coronavirus and efforts to contain the pandemic.
The Conference Board Consumer Confidence Index® declined in December to 88.6 (1985 = 100). This came after a decline in November, as well.
“Consumers’ assessment of current conditions deteriorated sharply in December, as the resurgence of COVID-19 remains a drag on confidence,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “As a result, consumers’ vacation intentions, which had notably improved in October, have retreated. On the flip side, as consumers continue to hunker down at home, intentions to purchase appliances have risen. Overall, it appears that growth has weakened further in Q4, and consumers do not foresee the economy gaining any significant momentum in early 2021.”
The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was up 12.15% in the fourth quarter, finishing the year up 18.40%. For technical analysts and trend followers, the index remains above its 200-day moving average. Something worth mentioning is that the strong performance by technology companies over the last 10 years means their influence has grown significantly on market-cap-weighted indexes, like the S&P 500. Note that technology, as well as other companies and sectors considered "growth" investments had very strong results in 2020. "Value" investments did start to gain traction in the fourth quarter, though, outperforming their growth counterparts during the last three months of the year.
International developed country equities (such as those in the European Union), measured by the MSCI EAFE index was up 16.05% in the fourth quarter, pushing performance for the year into positive territory. The index finished the year up 7.82%. Non-developed, or emerging countries (such as China, India, Brazil, or Russia) measured by the MSCI EM index, was again one of the better performers in the fourth quarter, up 19.70%. The strong performance propelled this index into positive territory for the year, as well, finishing up 18.31%.
U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, produced a positive 0.67% return in the fourth quarter, driving 2020 performance to 7.51%.
The 10-year U.S. Treasury bond yield was 0.93% at the end of the fourth quarter, which is lower in yield than where it began the year at 1.88%, but near the highest levels since the pandemic started.
If you plot interest rates versus the time-to-maturity to earn those rates, you have created a yield curve. In previous newsletters we have written in detail about the changing shape of the yield curve and what that may signal. Specifically, we follow the shape of the yield curve (plot of interest rates for different time periods). Using the U.S. Government 2-year bond rate as a proxy for short-term rates and the 10-year U.S. Government Bond rate as a proxy for long-term rates, we calculate the difference between the rates, which provides a possible indicator for the future direction of the economy. A steep spread (long-term rates higher than short-term rates) indicates possible future economic expansion and fixed-income investors are compensated for taking longer-term risk. A flat spread (long-term rates match short-term rates) is a possible indicator of economic uncertainty and longer-term investors are not being compensated for investing in longer-dated securities. An inverted spread (short-term rates are higher than long-term rates) possibly indicates future economic contraction.
The fourth quarter finished with the 2-year rate at 0.13% (same level as the end of the third quarter) while the 10-year moved higher to 0.93%. Technically speaking, that suggests an upward sloping or steep curve. The 80-basis point spread (a basis point represents 1/100 of 1%) is larger than where the year began, as well as at the end of the third quarter. Though steeper, we think it is safe to say that it is not steep enough to suggest the bond market is signaling a clear path for economic growth. As a point of reference, the shape of the yield curve was very steep in 2014, when the spread between the 2-year and 10-year was over 220 basis points (bp), signaling potential for growth. But, over time, the curve began to flatten, and became negative, or inverted in 2019, signaling potential for economic contraction. Though we do not think investors in 2019 were predicting a pandemic when the curve inverted, nonetheless, as a predictive indicator, the yield curve signal ended up being correct about economic growth, as we saw contraction in the second quarter of 2020. We share this information as a monitoring gauge, not as a basis to make any investment decisions.
Housing and Real Estate
Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index continued to try and move out of the hole created from the pandemic. The index was up 8.15% in the fourth quarter, but it was not enough, as the index finished down 5.12% YTD. Our investment committee at Baron continues to review challenges and opportunities for real estate. We hear opportunities are potentially increasing for areas related to tech, such as data centers and cell towers, self-storage, and healthcare, to name a few. While potential challenges and concerns remain for traditional office space, retail space and senior housing.
According to Freddie Mac (FM), the average 30-year residential home mortgage rate is near all-time lows at 2.79% with 0.7 Fees/Points. Two years ago, at the start of 2019, the rate was 4.51% (close to a seven-year high). The lower rates may continue to have a positive impact on the housing market. For those who have a current mortgage and have not refinanced in some time, it may be worth looking at potential options. Our Baron Answers Video: Should I Consider Refinancing My Mortgage, may answer some of your refinancing questions.
The Bloomberg Commodity Index (BCOM) increased in the fourth quarter, gaining 10.19%, however, performance for the year was still down at negative 3.12%. Though the index had a solid quarter, and the asset class appears to be moving in a positive direction, the overall slowdown in the economy continued to create challenges.
Baron Client Strategies
As you read through this newsletter, you may notice many of the investment categories had significant returns during the fourth quarter. The changes in investment values creates potential opportunities, so we have been extremely busy with client portfolios, including rebalancing. As clients know, we are fiduciaries and operate as fee-only advisors, so there is no benefit to us for making investment transactions. The reasons we make trades are to align clients' portfolios with their customized, risk-appropriate diversified strategy, and because we believe the actions we take are potentially strengthening the clients' portfolios or financial positions. We use the same approach with our own personal money.
No matter the economic environment, our basic principles remain:
Create a globally-diversified and risk-appropriate strategy. Validate the investment choices versus peer investments. Rebalance when needed. Test the strategy in a comprehensive financial plan and obtain regular feedback to update information and advance your financial position.
Your Service Plan
One of our primary roles is to educate our clients to make informed decisions about reaching their goals. Critical to that process are plan reviews, a process that focuses our attention on your goals, takes account of any changes in your situation and allows us to alter the course, as necessary. For more specifics, check out our “What You Can Expect” document by clicking the button below.
Your Personal Economysm
You may have heard us say that we are happy to help clients with issues outside of investing that may have an impact on their financial lives. We say things like “Lean on us when you are making a decision with anything with a dollar sign involved.” So, we have been including this section as a reminder of all our services and to share ways in which we can help clients outside of investing. .
If you are at or near an age where you are eligible for Social Security benefits or have a pension, you should reach out to us to help with the decision of how and when you should start collecting. The decisions are not easy. We have the experience and analytical tools to help you understand your different options, so that you can make the best decision for you, while understanding how the decision will impact Your Personal EconomySM.
Even if you are surprised by actual market movements and find yourself starting sentences with "I cannot believe that…", hopefully the planning process has outlined for you the impact to Your Personal EconomySM in different market environments. It is not bad if the actual market moves surprise you, it is bad if you do not understand how those moves impact you.
Baron Financial Group is proud to announce that Advisors Anthony Benante, Victor Cannillo, and Nicholas Scheibner are recognized as 2021 Five Star Wealth Managers in New Jersey. Anthony and Victor are proud to be multi-year award recipients for the past ten years in New Jersey. Anthony is also a multi-year recipient for wealth managers in Sarasota, Florida. Check out our website blog post for more information on the Five Star Wealth Manager Award.
Because meeting in-person is not as easy as it used to be, we continue to suggest clients consider a video meeting if you have not done so already. You do not have to be on camera, but we can be, and we can share our screens to help review reports and other information.
Without in-person meetings we have been creating more video content to help keep you informed and maintain a connection with your Baron Team. Hopefully you have seen our Holiday video. We have shared other videos recently (some will launch soon), instructing use of our Baron Portal, explaining cybersecurity and ways we protect client identity and data, answering questions about Your Personal EconomySM, and reviewing recent market performances.
We look forward to sharing additional educational, as well as fun videos throughout the year. Keep a look-out for these on the small screen and let us know what you think.
Remember that you can visit our website to gain access to your client portal. Just click on the client-portal tab, which will allow you access to view your account information. The client login requires a username and password to gain access through the portal. Please let us know if you would like to create your portal login or if you would like to learn more about what the portal provides.
Would you like to enroll in paperless Baron statements? Paperless statements will be accessible through our online client portal in the “Documents” section. You must be enrolled in the client portal to view your paperless statements. You will receive an email notification each quarter your statements are posted. Contact Baron at 1-866-333-6659 or at firstname.lastname@example.org to enroll.
For more educational content, please visit our Website Blog. The Baron Advisors are often called upon by journalists for their insights on financial planning and investing. They are quoted in such prestigious media outlets as The New York Times, CNBC.com, and NJMoneyHelp.com, among others.
We are proud of our philanthropic efforts, which include pro-bono work, as well as monetary donations to The Fair Lawn Food Pantry, the All Faiths Food Bank in Sarasota, the Adopt-A-Soldier Platoon, Spectrum for Living (serving adults with developmental disabilities) and the SCARC Foundation Capital Campaign (serving people with developmental disabilities). During this difficult time, when so many in our communities are struggling, we are focused on helping those in need.
Wishing all a happy, healthy, and prosperous New Year!
Baron Financial Group, LLC
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 10, 2021 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Baron Financial Group to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results. Therefore, an investor’s individual results may vary significantly from the benchmark’s performance.