Market Commentary The Pelican Bay Group

Transcription

1 Market Commentary The Pelican Bay Group November 20,2017 The Pelican Bay Group at Morgan Stanley 1250 Pittsford Victor Rd. Building 200, Suite Fifth Avenue, 11 th Floor New York, NY Market Street Suite North Military Trail Suite N. Oregon St. Mills Building, 9 th Floor El Paso, TX Visit our website: Contact us please call: (800) Portfolio Management Team There is no theme this week. We thought we might highlight a few items that have caught our interest. Some of these may be on your radar and can provide confirmation, disagreement or something that perhaps you may not have been thinking about. In regard to tax reform, we polled a half dozen top bracket taxpayers (39%), to see if they were getting a tax increase, cut or remaining the same. It is fair to say they all feel they are either staying the same, or, in the case of taxpayers in high local/state tax states (the SALT states), a tax increase due to loss of deductibility. And for those with a heavy mortgage, in a high tax state, more of an increase. All agreed that the changes coming in the estate tax would benefit their families, but you know, it s kind of obvious that they themselves won t get any benefit, given that the tax break would come after their personal termination date (Hard to find the right words to express things sometimes). While there are always exceptions to the rule, we don t believe that the vast majority of top bracket individual taxpayers (a.k.a. the rich as they re called) will see any kind of tax windfall from the proposed legislation. Doesn t mean we agree with the changes (some we like, some we don t) but sometimes misinformation can fill the air and clog thinking. The high yield bond market exists to offer a funding vehicle for companies not meeting stringent bank or investment grade rating criteria. Often called the junk bond market, investors seek investment for a yield pick-up. We ourselves are not high yield investors so we observe that market more from what it might be saying about overall conditions rather than whether we want to invest in it. And we would also say that calling them junk bonds is not at all accurate. Some are, and some aren t, but they are all high yield bonds and we prefer that for accuracy. At any rate (no pun intended), high yield has been a bit wobbly recently, and that s new. Here, a chart of the ishares iboxx High Yield ETF (we are not recommending buy/sell/hold, just using it for illustration) which follows the iboxx High Yield Index, with the S&P 500: At any rate (no pun intended), high yield has been a bit wobbly recently, and that s new. Here, a chart of the Merrill Lynch High Yield Master II Index (Source: Reuters EIKON). Even as the equity market made new highs recently, this has clearly tailed off: The Pelican Bay Group assists high net worth individuals and institutional clients in meeting their financial objectives by offering customized portfolio management strategies. The Pelican Bay Group, a team of Morgan Stanley s, has four experienced portfolio managers covering an array of disciplines and offering a variety of strategies designed to optimize risk to help meet their clients investment objectives. These investment styles are offered as fully discretionary strategies with a comprehensive fee based on the asset value being managed. The team currently manages over $2 billion in client assets.

2 After trending tightly, they have begun to diverge. Historically, a divergence has spelled trouble for equities. Perhaps high yield bond investors are more sensitive to changing conditions than equity investors. Both take on risk, but they come at it from a different perspective one from credit analysis and the other from forward-looking earnings analysis. They aren t mutually exclusive since forward earnings can help tell you if the bond is money good, but the bond investor wants a coupon and to be paid on maturity, the equity investor looks for a dividend, but has no maturity to consider. Here, the spread between high yield bonds (in aggregate) and the 10-year US Treasury. When the spread is low (say, high yield pays 6% and the Treasury, 2%, a spread of 4%), investors are complacent, willing to take less of a yield premium because they feel safe in their investment. Conversely, when the spread widens (high 8%, spread now 6%), investors are demanding more return over a safe alternative. You can see clearly below that spreads today are as low as they ve been in 20 years, but the spread is coming up off the floor. You might read commentary that if the spread widens, it will signal imminent trouble for the stock market. That may or may not be true, but consider that the spread began to rise in 1998, but the stock market didn t peak for two more years. And in 2014, the spread began to widen considerably into 2016, but posed a false signal to a market decline (Although the market did swoon in early 2016, it didn t last) Nevertheless, we do not find value in high yield at these levels. Just consider the situation in Europe: These yields wouldn t attract us, but we have little doubt that given the history, investors will at some point clamor for additional yield which all things being equal, would drop prices.

3 We like to see major stock indices all travel together. So, when they go out of kilter, we take notice. Here, the Dow Jones Transportation Index and the Dow Jones Industrial Average, have diverged: The Dow Theory states that in a healthy economy and market, the companies transporting the goods can often lead the companies using and making the goods and so, you want to see transportation stocks doing well. They peaked a couple of months ago, and that divergence, like the divergence in high yield, has caught out attention.. These are both what we might call canaries in the coal mine. The problem is that sometimes the canaries warble and sometimes they warble just for fun, and then they stop. Another divergence, in a different direction: Here, utility stocks have been screaming higher. The DJ Utility index has a yield of 3% and we think the price movement in utilities has been a yield stretch, people seeking higher cash flows. We are not convinced that the fundamentals of delivering power to your home justifies a near 30% year over year increase. Perhaps this speaks of excess. With earnings season coming to a conclusion, all eyes shift back to Washington for the next catalysts for markets. Failure in tax reform would have negative consequences, success might be already priced in, but our guess would be there

4 is enough concern so that any passage would generate a swift rally which might or might not hold. Stocks appear a bit tired to us. We are in a very strong seasonal period of time now (through January, tends to be strong), offset by some sense of fatigue, if we read investor sentiment correctly. No matter, the Thanksgiving holiday is upon us. Better pens than ours will talk about thanks for the truly important things. Here, with our more narrow (and admittedly economic) point of view, we can be thankful for a nine year bull market, in nearly all assets. After you give thanks for family, your health, your faith, your country, you can put that somewhere on the list. Wouldn t hurt. Might need all the help we can get. Tony Who Is The Pelican Bay Group? Our team of financial professionals is national in scope with s stationed in strategic locations across the country. As part of Morgan Stanley, one of the world s most respected financial services firms, we offer access to extensive resources that can prove instrumental in helping you meet even your most complex financial challenges. Our team members include: Anthony M. Gallea Managing Director-Wealth Management Jennifer D. Hartmann, CIMA Managing Director-Wealth Management Senior Institutional Consultant Family Wealth Advisor New York, NY Stephen Stribling, CPM Executive Director-Wealth Management Teresa Bustamante Senior Investment Management Consultant El Paso, TX Marcia Bonnet Associate Vice President Financial Planning Specialist Family Wealth Advisor Mark S. Ryan, CFP First Vice President-Wealth Management Portfolio Management Director Richard J. DiMarzo, CPM Paul M. Hanrahan, CRPS Professional Alliance Group Director Shelley Ford Jeff Praino, CFP Certified Divorce Financial Analyst Financial Planning Specialist William VandenBrul Vice President-Wealth Management Wealth Advisor Jeanine Delgadillo Cynthia Walker-Laroche Vice President-Wealth Management

5 The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Wealth Management or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results. S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index. Dow Jones Industrial Average is a price-weighted index of the 30 blue-chip stocks and serves as a measure of the U.S. market, covering such diverse industries as financial services, technology, retail, entertainment and consumer goods. An investment cannot be made directly in a market index. The investments listed may not be suitable for all investors. Morgan Stanley Smith Barney LLC recommends that investors independently evaluate particular investments, and encourages investors to seek the advice of a financial advisor. The appropriateness of a particular investment will depend upon an investor's individual circumstances and objectives. Information contained herein has been obtained from sources considered to be reliable, but we do not guarantee their accuracy or completeness. Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate. Morgan Stanley Smith Barney LLC. Member SIPC. Date of first use: 11/20/2017 CRC