October, 2017 LOWER ITEREST RATES EABLE THE S&P 500 TO KEEP O CLIMBIG By Louis P. Stanasolovich, CFP, CCO, CEO and President of Legend Financial Advisors, Inc. and EmergingWealth Investment Management, Inc. any investors are concerned that the stock market continues to rise precipitously with seemingly no end in sight. Generally, when this happens, a Bear Market-like decline often occurs. While it appears this may be true, there are extenuating factors. One of the major factors affecting stock market valuations is the level of interest rates. M As shown on Chart 1 on page 4 entitled 2-Year And 10Year Treasury Yields, 2-year (the red line) and 10-year (the green line) interest rates were approaching 8.0% in Lower Interest Rates, continued on page 4 RAY DALIO: A FAMOUS HEDGE FUD MAAGER Views on the Stock Market, The Fed and Interest Rates Ray Dalio Biography: Raymond Dalio is an American investor, hedge fund manager and philanthropist. Dalio is the founder of investment firm Bridgewater Associates, one of the world s largest hedge funds. Via Stephen B. Blumenthal, Founder and CEO, CMG Capital Management Group, Inc. Excerpted from a ThinkAdvisor interview by Louis P. Stanasolovich, CFP, CCO, CEO and President of Legend Financial Advisors, Inc. and EmergingWealth Investment Management, Inc. Ray Dalio, continued on page 6 UDERSTADIG THE YIELD CURVE By Diane M. Pearson, CFP, PPCTM, CDFA, Legend Financial Advisors, Inc. and EmergingWealth Investment Management, Inc. A typical yield curve chart for U.S. Treasuries (although this is the most common one, it can be for any type of bond) is a graphical representation showing the yields for each bond s maturity. This graph usually ranges from three-months to 30 years. Plotting these yields on a graph with the y-axis (running up and down; in other words, vertically) being the yield and the x-axis (running left to right; in other words, horizontal) being the time to maturity and then connecting a specific point produces the yield curve for that point in time. The shape of the yield curve changes over time due to market forces and other factors such as monetary and fiscal policy. Many investors and most intelligent ones monitor the curve to gather information about future economic growth. The three types of yield curves are upward sloping, flat, and downward sloping also known as inverted. Listed below is the information explained by the variyield Curve, continued on page 5 ous types of yield curves. VALUATIO-BASED COUTRY SELECTIO/ROTATIO By Jun Zhu, CFA, Senior Analyst, The Leuthold Group, LLC In the Leuthold Group s August Perception Express, they back tested 20 years of data (1997-2017) to assess the effectiveness of employing valuation factors for country selection. We concluded that, specifically for Emerging Markets, nearly all the valuation factors under review worked Valuation-Based, continued on page 8 THE GLOBAL IVESTMET PULSE, October, 2017 1
Editor Louis P. Stanasolovich, CFP CCO, CEO, and President Legend Financial Advisors, Inc. 5700 Corporate Drive, Suite 350 Pittsburgh, PA 15237-2829 legend@legend-financial.com ewsletter Production Managers Lori. L. Albert legend@legend-financial.com ABOUT LEGED FIACIAL ADVISORS, IC. Legend Financial Advisors, Inc. (Legend) is a on-commission, Fee-Only, Fiduciary U.S. Securities and Exchange Commission registered investment advisory firm with its headquarters located in Pittsburgh, Pennsylvania. Legend provides Personalized Wealth Management Services Including Financial Planning And Investment Management Strategies to affluent and wealthy individuals as well as business entities, medical practices and non-profit organizations as well as retirement plans. Legend and its award-winning advisors are Fiduciaries. FIVE REASOS TO CHOOSE LEGED 1. Legend is a on-commission, Fee-Only, Fiduciary advisory firm. Fee-Only means Legend is compensated exclusively by client fees. Unlike Legend, fee-based advisors and brokerage firms have numerous conflicts of interest due to the fact that they receive commissions. EmergingWealth Investment Management, Inc. 5700 Corporate Drive, Suite 360 Pittsburgh, PA 15237-2829 Postmaster: Send all address changes to: Legend Financial Advisors, Inc. 5700 Corporate Drive, Suite 350 Pittsburgh, PA 15237-2829 Copyright 2017 by Legend Financial Advisors, Inc and EmergingWealth Investment Management, In Reproduction, photocopying or incorporating into a information-retrieval system for external or interna use is prohibited unless permission in each case f a specific article. The subscription fee entitles the subscriber to one original copy only. Unauthorized copying is considered theft. LOUIS P. STAASOLOVICH, CFP, EDITOR Louis P. Stanasolovich, CFP is founder, CCO, CEO and President of Legend Financial Advisors, Inc. (Legend) and EmergingWealth Investment Management, Inc. Lou is one of only four advisors nationwide to be selected 12 consecutive times by Worth magazine as one of The Top 100 Wealth Advisors in the country. Lou has also been selected 13 times by Medical Economics magazine as one of The 150 Best Financial Advisors for Doctors in America, twice as one of The 100 Great Financial Planners in America by Mutual Funds magazine, five times by Dental Practice Report as one of The Best Financial Advisors for Dentists In America and once by Barron s as one of The Top 100 Independent Financial Advisors. Lou was selected by Financial Planning magazine as part of their inaugural Influencer Awards for the Wealth Creator award recognizing the advisor who has made the most significant contributions to best practices for portfolio management. He has been named to Investment Advisor magazine s IA 25 list three times, ranking the 25 most influential people in and around the financial advisory profession as well as being named by Financial Planning magazine as one of the country s Movers & Shakers recognizing the top individuals who have done the most to advance the financial advisory profession. 2 THE GLOBAL IVESTMET PULSE, October, 2017 2. Members of Legend s Financial Advisory Team have been selected by ational Publications such as Worth, Medical Economics and Barron s more than 60 times as The Best Financial Advisors In America. 3. Unlike most advisory firms and all brokerage houses, Legend and its advisors have chosen to be governed by the Fiduciary Standard of Law. Fiduciaries are required to work in their clients best interests at all times. 4. Legend designs dynamic, creative and personalized financial planning and investment solutions for its clients. 5. Legend emphasizes low-cost investments where possible that are allocated and traded in an income tax-efficient manner. ABOUT EMERGIGWEALTH IVESTMET MAAGEMET, IC. EmergingWealth Investment Management, Inc. (EmergingWealth), is the sister firm of Legend Financial Advisors, Inc. (Legend) and is a on-commission, Fee-Only Securities and Exchange Commission (SEC) registered investment advisory firm. EmergingWealth provides Investment Man- agement services to individuals as well as business entities, medical practices and non-profit organizations whose wealth is emerging. All investment portfolios are sub-advised by Legend. Both Legend and EmergingWealth share a common advisory team, Investment Committee and Fee Schedule.
RECESSIO RISK IS HIGHLY DEPEDET O IFORMATIO FROM STOCK PRICES By William Hester, CFA, The Hussman Funds Excerpted by Diane M. Pearson, CFP, PPC TM, CDFA, Legend Financial Advisors, Inc. and EmergingWealth Investment Management, Inc. In his September 1966 ewsweek column, the economist, Paul Samuelson quipped that the stock market had predicted nine of the last five recessions. Although it was originally delivered as a joke, in the nearly five decades since the statement, it has turned out to be an accurate description of stock movements and the economy. Since 1950, the market has fallen decidedly below its 12-month moving average 22 times while the economy has experienced 10 recessions, holding fairly close to Samuelson s originally suggested ratio. While Samuelson s quote is often used in a dismissive way to suggest that stock market corrections have no role in forecasting the economy, it s sometimes overlooked that over the past 65 years, a drop in stocks has occurred prior to or at the start of every recession, without missing a single contraction. Stock market declines clearly play a role in anticipating recessions, even if they don t always signal recessions all by themselves. While it may be preferable to exit the market or hedge equity exposure prior to a decline, this is valuable information even once a decline is underway that can be used to gauge further stock market risks. And it turns out that a drop in the stock market, when combined with a set of capable leading economic indicators, better classifies economic and stock market risks than relying on economic indicators alone. Stock market corrections come in two forms, although the two often overlap one another. One is a pure contraction in valuation multiples, where prices plummet, but fundamentals like revenue and earnings remain mostly unchanged. This typically occurs when there is an abrupt change in investor attitudes toward risk. The correction of 1962 and the crash of 1987 are examples of these kinds of corrections. The economy continued to expand for years after each market correction. The second type is coupled with broadly worsening fundamentals, where the economy slows, earnings get hit, and stocks fall. Of course, as the outlook dims for earnings, investors often drive down the valuation multiples paid for those earnings as well. That s why stock market corrections within and around recessions tend to be the deepest. Source: This article was excerpted from When Market Trends Break, Even Borderline Data Is Recessionary, by William Hester, CFA, The Hussman Funds, (Weekly Market Comment, October, 2015), www. hussman.com COPYRIGHT 2017 THE HUSSMA FUDS REPRITED WITH PERMISSIO OF THE HUSSMA FUDS 1.30 1.20 1.10 1.00 0.90 Y Y Y Y Y Y? 0.80 Y Y 0.70 Y Y 0.60 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Recession As of: October, 2015 COPYRIGHT 2017 THE HUSSMA FUDS Ratio of the S&P 500 and its 12-Month Moving Average Source: The Hussman Funds, Investment Research & Insight, October, 2015, www.hussman.com REPRITED WITH PERMISSIO FROM THE HUSSMA FUDS PULSE THE GLOBAL IVESTMET PULSE, October, 2017 3
Lower Interest Rates, continued from page 1 1995 decreasing slightly to approximately 6.75% at the beginning of 2000. Stock market valuations on a Price-To-Earnings Ratio (P/E) calculation by Robert Shiller s famed study of 43 indicated that the stock market was too expensive when compared with interest rates. The market rout was on. A total decline in the stock market of 47.4% (a Severe Bear Market), as evidenced by the S&P 500, began on March 23rd of 2000 and ended on October 9th of 2002. Please notice that either interest rate did not increase to any great degree until approximately six months after the end of the stock market decline. Coincidently, this was after the recession (the gray shaded area on the chart) ended. The stock market (S&P 500) being a leading indicator had already been rising before interest rates started to rise. Over the next five years, both interest rates and the stock market continued to increase once again. At which point (October 9th of 2007), the stock market began its second Severe Bear Market of the decade. This time, the decline was 55.2% accompanied by what is called a Severe Recession [a recession where Gross Domestic Product (GDP) declines by 5.0% to 10.0% - this one declined 5.1%]. Many people refer to the 2008 recession as The Great Recession (Many people refer to it as The Financial Crisis.), the worst recession since The Great Depression. Since the end of The Great Recession, interest rates have largely moved sideways as evidenced by Chart 1. The Central Banks of the world The U.S. Federal Reserve (The FED) included that have pushed down interest rates to unusually low levels through Quantitative Easing (QE) in the U.S. and Europe as well as negative interest rates in Europe and Japan, have created an extremely attractive investment environment for equities. This has lead to near record returns in the U.S. since the beginning of 2012. If interest rates remain near current levels, we would expect continued stock market increases, but perhaps not as robust, until the U.S. economy slows. When that occurs, it is anyone s guess. Currently, it appears that interest rates are very unlikely to skyrocket in the U.S. and/or other major countries around the world, therefore, the stock market is likely to increase for at least the next few years. As for the recession discussion, for now, the world s economies are actually expanding. COPYRIGHT 2017 LEGED FIACIAL ADVISORS, IC. REPRITED WITH PERMISSIO OF LEGED FIACIAL ADVISORS, IC. 8% 7% 6% 5% 2-YEAR AD 10-YEAR TREASURY YIELDS vs. S&P 500 IDEX 1/1/1995-9/30/2017-47.4% -55.2% Recession Periods 10-Year Treasury Yields 2-Year Treasury Yields S&P 500 Index (RHS) 2500 2000 4% 3% 1500 2% 1% 1000 0% -1% 10/9/2007 Start of stock market decline 3/9/2009 End of stock market decline 500-2% -3% 3/23/2000 Start of stock market decline 10/9/2002 End of stock market decline 0 1/1/1995 1/1/1996 1/1/1997 1/1/1998 1/1/1999 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014 1/1/2015 1/1/2016 1/1/2017 As of: September 30, 2017 Source: Bloomberg COPYRIGHT 2017 LEGED FIACIAL ADVISORS, IC. PULSE 4 THE GLOBAL IVESTMET PULSE, October, 2017
Yield Curve, continued from page 1 In so-called normal or good economic times, the yield curve generally slopes upward to the right with shorter-term yields lower than longer-term yields. From purely a risk/reward viewpoint; investors should be compensated more for investing longer term periods of time. In other words, higher yields for longer maturities. When the Federal Reserve cuts interest rates to revive an economic slowdown, it forces down interest rate yields on short-term bonds so that they are lower relative to longer-maturity bonds. A growing economy may also result in higher inflation. Inflation endangers long-term bond holders since it can significantly decrease the value of bonds. Traditional bonds don t adjust for inflation unless they are inflationlinked bonds like Treasury Inflation Protection Securities (TIPS). To entice buyers to buy longterm bonds, yields would have to increase. In either case, an upward-sloping yield curve generally means the economy is doing well or expected to do well in the future. A flat yield curve means there is very little difference between short-term yields and longer-term yields. In other words, investors essentially receive about the same interest rate whether they purchase a two-year bond or a 30-year bond. Why would an investor invest in a long-term bond with the same yield as a two-year bond? One of the reasons could be the Federal Reserve would increase short-term interest rates in an attempt to slow the economy and keep inflation in check. As a result, if enough investors believe that the economy is going to slow 3% 2% 1% 0% -1% -2% -3% 6/30/1976 6/30/1978 6/30/1980 6/30/1982 As of: September 30, 2017 YIELD SPREADS OF 2-YEAR AD 10-YEAR TREASURIES 6/30/1976-9/30/2017 6/30/1984 down substantially, many will invest in higher yields of longer-term U.S. Treasuries. Such a so-called rush into U.S. Treasuries could accelerate this Flattening effect as investor demand increases for longerterm bonds. Therefore, interest rates decrease. Another important point to make about a flat yield curve is that it does not mean that, economically speaking, that we are about to fall off the recessive cliff. The graph at the end of this article indicates the difference between the two-year and 10-year U.S. Treasuries. Whenever the spread is negative [the yield on the two-year U.S. Treasury Bond exceeds the 10-year U.S. Treasury Bond, we will soon have a gray bar (The gray bar indicates a recession.)]. In normal times, 10-year U.S. Treasury yields exceed twoyear U.S. Treasury yields. This means the U.S. economy is starting the recovery process or has recovered. It also should be noted that the spread can be narrow (flatter curve) for some time without a recession. 6/30/1986 6/30/1988 6/30/1990 6/30/1992 6/30/1994 Recession Periods 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity 6/30/1996 6/30/1998 6/30/2000 6/30/2002 6/30/2004 6/30/2006 Source: Bloomberg COPYRIGHT 2017 LEGED FIACIAL ADVISORS, IC. Referring again to the graph at the end of the article, the yield curve is considered inverted if the spread drops below zero, meaning the yield on the two-year Treasury is greater than the yield on the 10-year Treasury. Currently, the yield curve for U.S. Treasuries is upward-sloping (considered a normal yield curve) as the economy continues to grow. Short-term interest rates will eventually rise. However, the longer interest rate end of the yield curve can be, and usually are, influenced by investors expectations about economic growth. Given the history of interest rates and the corresponding yield curve, investors should always monitor interest rates for signs of trouble or opportunities. 6/30/2008 6/30/2010 6/30/2012 6/30/2014 COPYRIGHT 2017 LEGED FIACIAL ADVISORS, IC. REPRITED WITH PERMISSIO OF LEGED FIACIAL ADVISORS, IC. 6/30/2016 PULSE THE GLOBAL IVESTMET PULSE, October, 2017 5
Ray Dalio, continued from page 1 ThinkAdvisor Magazine: Do you see a disconnect between the U.S. stock markets being at an alltime high, while at the same time the economy continues to grow slowly? Ray Dalio: o, I don t. Markets, in general, are driven by the interest rate. As interest rates go down, as they have, that s helped. Second, the purchases of financial assets by central banks have pushed asset prices up. Third, the expected returns of bonds and equities going forward are at relatively normal premiums to the existing short-term interest rate. ThinkAdvisor Magazine: What are the implications of all that? Ray Dalio: People buy profits, not the economy. So, if the corporate tax rate is cut, a company is worth more even though the economy might or might not pick up on that. If regulation is reduced, that stimulates business. It might have other consequences, but it causes profits to rise. ThinkAdvisor Magazine: Any other critical reason for what s happening in the economy and market? Ray Dalio: Technology, which is improving profitability, is also worsening employment. That worsens the economy because technology is replacing people in jobs. Improving profitability through technology is good for companies but not good for the economy as a whole because the people losing jobs are also the people who are more inclined to spend income. I call that group the lower 60.0%. As a result, technology helps profits but hurts employment and helps to cause a slower economy at the same time it has caused companies to be worth more. ThinkAdvisor Magazine: Has the U.S. ever been in a situation like that before? Ray Dalio: We had a similar situation between 1935 and 1940. I would say that 1937 [during the Great Depression, two years before the start of World War II] is most like 2017. We had the same sort of debt crisis; interest rates went to zero and the central banks printed a lot of money and bought financial assets, which went up in price. We had the same sort of wealth gap and the same sort of populism around the world. ThinkAdvisor Magazine: Is there a lesson from 1937? Ray Dalio: It s very important that the Federal Reserve be very cautious and slow to tighten monetary and fiscal policy because we have asymmetrical risks: many more risks on the downside than on the upside. It s best to be cautious about how political and social conflict is handled. Can we work together, or are we going to be split? Even though the stock market is at its peak and the unemployment rate is at a low, for the bottom 60.0% it s a bad economy. We must not have an economic downturn. ThinkAdvisor Magazine: On Decision Making You write that collective decision-making is the secret sauce behind your success. How so? Ray Dalio: In order to be successful in the market, as I said, you have to be an independent thinker who bets against the consensus and is right. It s so easy to be wrong. If you have quality collective decision-making with people who are willing to disagree well and work themselves through it well, you raise the probability of being right. ThinkAdvisor Magazine: You stress in your book that one of the greatest tragedies is people persisting to hold opinions in their head that are wrong. Why is that a tragedy? Ray Dalio: They don t put them out to stress-test, and that causes them to make worse decisions. If people could be more open-minded and assertive at the same time, they can learn a lot. You can t be attached to what you know. That s the most important thing in my book. It s also important to learn from painful mistakes. ThinkAdvisor Magazine: Debt and Demographics Two Powerful Ds Ray Dalio: The global economy continues to improve. Recession probability for the U.S. remains minimal in the next six to nine months. Europe s economy is on better footing. Risks persist, including orth Korea, a sharp slowdown in China, fiscal dysfunction in the U.S. (e.g., tax cuts, fiscal spend), and growing protectionist risks to global trade. Debt remains a significant headwind to growth. Source: This article was excerpted from Trust, Commitment and Love, By Stephen B. Blumenthal, Founder and CEO, CMG Capital Management Group, Inc., (On My Radar, October 2, 2017), www.cmgwealth.com COPYRIGHT 2017 CMG CAPITAL MAAGEMET GROUP, IC. REPRITED WITH PERMISSIO OF CMG CAPITAL MAAGEMET GROUP, IC. PULSE 6 THE GLOBAL IVESTMET PULSE, October, 2017
Small-cap stocks, as measured by the Russell 2000 Index were among the biggest winners immediately following the ovember election, the idea being that President Trump s America first policies would benefit smaller, domestic companies with less exposure to foreign markets to the most. That ended in mid-december, 2016 prior to President Trump s inauguration. This trade was put on hold somewhat as Mr. Trump s pro-growth agenda repeatedly stalled in Congress. However, renewed talks of tax reform recently excited investors, helping to push the Russell 2000 back into record-closing territory. For the 12-month period, the index of American small-cap stocks is beating the S&P 500 by nearly 3.0%. The bottom line is that Congressional Republicans and Trump need this win after the multiple failed attempts to repeal and replace The Affordable Healthcare Act. Tax reform theoretically should be much easier to SMALL STOCKS MOVIG UPWARD FIALLY However, The Move Could Be Short-Lived By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors achieve than repealing the healthcare law. A potential wrench in the Congressional apparatus is the tax code has not been fundamentally changed in more than 30 years. Tax reform is much more difficult than tax cuts. For individuals, the number of personal income tax brackets will fall from seven to three and the top marginal tax bracket will decrease from 39.6% to 35.0%. It should be noted that some individuals will pay more in income tax. The corporate tax rate would be set at 20.0%, down from 35.0% currently the highest rate in the world among developed economies. This should help U.S.-based firms become much more competitive, and ideally it would encourage multinationals to bring home the estimated $3.6 trillion in cash held overseas. The Trump Administration has not been successful at trying to implement its policies so far. Should the tax reform proposal not be passed, we could see a significant retraction in small stock prices. In other words, proceed with caution. The Tax Policy Center recently released the first major analysis of President Trump s tax plan. The analysis shows the bulk of benefits from the plan would go to the top 1.0% of income earners in the U.S. while the plan would actually increase taxes on a segment of the middle class. Source: This article was excerpted from This Could Be A o-brainer Gold Buying Opportunity, By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors, (Advisor Alert, October, 2017), www.usfunds.com COPYRIGHT 2017 U.S. GLOBAL IVESTORS REPRITED WITH PERMISSIO OF U.S. GLOBAL IVESTORS U.S. TAX CODE HAS T BEE OVERHAULED I A GEERATIO As of: October, 2017 COPYRIGHT 2017 U.S. GLOBAL IVESTORS Source: U.S. Global Investors, Advisor Alert, October, 2017, www.usfunds.com REPRITED WITH PERMISSIO FROM U.S. GLOBAL IVESTORS PULSE THE GLOBAL IVESTMET PULSE, October, 2017 7
Valuation-Based, continued from page 1 as expected, and quite well, judging by the cumulative return spreads between expensive countries and cheap countries. This sequel study digs deeper to examine the results and the investment implications of factor performance within sub-periods of that 20-year time frame. In summary, we found that most of the anticipated return spread occurred during the first 10 years. Valuation Factors In Two Sub- Periods: 1997-2007 And 2007-2017: Charts 1-4 plot the relative strength of cheap Emerging Markets countries versus expensive Emerging Markets countries based on the four valuation metrics presented in the August report (LTM Price to Earnings, Price to Cash Flow, Dividend Yield, and Price to Book). Rising RS (dark lines on charts) indicates cheap countries are outperforming expensive countries. The four charts below show that the predictive power manifested during the period from 1997 to 2007. Cheap countries outperformed consistently during that time. However, since 2007, the pattern has reversed. Cheap countries based on Price-To Book valuations and Price-To-Cash Flow have underperformed expensive countries (Charts 2 & 3), while the effectiveness of PE is questionable as the RS line has remained range bound. Despite generating a nar- CHART 1 Test Price-To-Earnings Ratio (1997 Current, Emerging Countries) CHART 2 Test Price-To-Cash Flow (1997 Current, Emerging Countries) CHART 3 Test Price-To-Book (1997 Current, Emerging Countries) CHART 4 Test Dividend Yield (1997 Current, Emerging Countries) Valuation-Based, continued on page 10 8 THE GLOBAL IVESTMET PULSE, October, 2017
Do You Want A Second Opinion? To see if your investment portfolio is built to navigate the pitfalls and opportunities ahead, call us today for a Free Second Opinion at (888) 236-5960 www.legend-financial.com THE GLOBAL IVESTMET PULSE, October, 2017 9
Valuation-Based, continued from page 8 rower cheap/expensive country return spread over the 20-year testing period, Dividend Yield is the only metric that demonstrated consistency in both sub-periods. Chart 4 shows that based on Dividend Yield, the relative strength of cheap Emerging Markets countries versus expensive Emerging Markets countries has been in a general uptrend. We analyzed Developed Markets to see if the same observation can be made. Charts 5-8 are plots of relative strength between cheap Developed Markets countries versus expensive CHART 5 Developed Markets Price-To-Earnings Ratio (1997 Current) Developed Markets countries based on the four valuation metrics. Rising RS (dark lines) means cheap countries are outperforming expensive countries. Charts 5-8, below, indicate that the valuation metrics predictive power was observed only during the 1997-2007 period, with cheap countries consistently outperforming. From late 2007 to late 2015, however, the trend reversed, much like what happened with the Emerging Markets analysis. The reversal is even more pronounced among Developed Markets countries. During 2007-2015, buying cheap Developed Markets turned out to be a losing strategy, significantly lagging the portfolio consisting of the most expensive Developed Markets countries. Since early 2016 however, the trend reversed to again favor Developed Markets countries with low valuations. The latest shift back to value for Developed Markets has yet to be observed among Emerging Markets countries. ote that contrary to the Emerging Markets result, the Dividend Yield performance cycle of the Developed Markets segment is in sync with the other valuation metrics. CHART 6 Developed Markets Price-To-Cash Flow (1997 Current) CHART 7 Developed Markets Price-To-Book (1997 Current) CHART 8 Developed Markets Dividend Yield (1997 Current) Valuation-Based, continued on page 11 10 THE GLOBAL IVESTMET PULSE, October, 2017
Valuation-Based, continued from page 10 Why Did Valuation Factors Work In 1997-2007, But ot In 2007-2017?: 1) Country Return Divergence Is Higher During The First Half Of The 1997-2007 Period. Factor effectiveness to pick winners and losers first depends on how underlying returns are correlated. Highly correlated returns lead to narrow return divergence, making it hard for any quant factor to work. The return differentials of the five best and worst performing countries are plotted on Charts 9 & 10, below; it appears correlations for both Emerging Markets and Developed Markets were much wider during 1997-2003. Since then, except for the 2008-2009 financial crisis period, countries have tracked each other more closely. The historical trend may partially explain why valuation factors performed well during 1997-2007, but this is not the whole story. Consider the following: 1) Wide return divergences were only observed during 1997-2003, but valuation factors continued to be effective in the 2003-2007 period. 2) Even though larger divergences help explain good value factor per formance during 1997-2007, it doesn t explain why value factors didn t work at all from 2007-2017 when the return spread between cheap and expensive countries not only narrowed, but reversed. CHART 9 Emerging Markets Differential Best Performing Emerging Market Countries Minus Worst Performing Emerging Market Countries CHART 10 Developed Markets Differential Best Performing Developed Market Countries Minus Worst Performing Developed Market Countries Valuation-Based, continued on page 12 THE GLOBAL IVESTMET PULSE, October, 2017 11
Valuation-Based, continued from page 11 Another explanation for value factor performance is based on the trend of the divergence. Charts 9 & 10 show clear patterns of narrowing return divergences among countries from 1997 to early 2007. Is it possible that when the country premium is declining (investors are less risk-averse, which is associated with lower valuations), the countries with low valuations tend to outperform? Since the 2008 financial crisis, the country premium has not changed much, thus higher risk/ lower valuation countries haven t had any advantage. 2) Is Value/Growth Cycle Applicable At The Country Level? Could value factor performance at the country level follow the general value/growth cycle at the stock level? Charts 11 & 12 are value/growth cycles we track for Large, Mid, and Small Caps, which show similar patterns during 1997-2007. Growth outperformance registered from 1997-2000, followed by a value cycle from 2000-2003. From 1997 to 2007, country level value-factor performance did not track the same pattern as shown in Charts 11 & 12, below. Instead, value continued to outperform through the whole period on the country level, even though a different growth/value regime was recorded at the stock level. CHART 11 Large Cap Growth Versus Large Cap Value Cycle CHART 12 Mid/Small Cap Growth Versus Large Cap Value Cycle Valuation-Based, continued on page 13 12 THE GLOBAL IVESTMET PULSE, October, 2017
Valuation-Based, continued from page 12 From 2007-2017, Large Caps recorded a decisive growth cycle (Chart 11), while no leadership is observed among Mid and Small Caps (Chart 12). This helps explain the observation that during the same period, cheap countries underperformed. Putting it all together, we are still not convinced that value factor performance on the country level follows the growth/value cycle at the stock level. There could be some other drivers at work. 3) Does Factor Strength Explain Value Factor Performance In The Two Sub-Periods? Factor strength is defined as the valuation differential between the most expensive and least expensive countries. The hypothesis is that a large valuation gap drives wider return differentials during a value cycle. Contrary to the hypothesis, Chart 13, below, shows that when factor strength (measured by the PB valuation metric) was below historical average during 2000-2005, value worked the best. We do, however, notice much higher volatility of factor strength during 1997-2007. Charting of other valuation factors shows the same pattern. Could the effectiveness of value factors be positively linked to the volatility of factor strength, instead of its absolute level? CHART 13 Factor Strength and Cheap/Expensive Country RS Black Line: Average PB of Most Expensive Countries Minus Average PB of Cheapest Countries Grey Line: Cheap Countries versus Expensive Countries Relative Strength (Right Y-Axis) CHART 14 Market Valuation Cycle and Cheap/Expensive Country RS Black Line: PB of MSCI EM Index (dashed line=historical median) Grey Line: Cheap Countries versus Expensive Countries Relative Strength (Right Y-Axis) Valuation-Based, continued on page 14 THE GLOBAL IVESTMET PULSE, October, 2017 13
Valuation-Based, continued from page 13 4) Does The General Market Valuation Phase Account For The Value Factor Effectiveness? Do value factors work better when market valuation is generally rising/ falling? Chart 14 (on the bottom of page 13) aligns the overall market valuation (based on Price to Book, dark line) with the RS of cheap countries versus expensive countries. Again, there is no decisive correlation observed between these two data sets. From 1999-2007, market valuations first experienced a decline, and then rose, but the value factor continued to work quite well during that period. However, looking at the longer-term cycle, we notice the general uptrend of market valuations from 1997-2007, and this overlaps with the period when value factors worked at the country level. In addition, from 2007-2016 when Emerging Markets valuations were in a general decline, value factors failed to pick the winning countries. 5) Could The Value Factor Cycle Simply Reflect Sector Rotation? Chart 15, below shows the RS (dark line) of low valuation sectors (Energy, Materials, Utilities, Industrials, Financials) versus high valuation sectors. The trend of sector relative performance aligned quite well with the performance of low valuation countries relative to high valuation countries. Since some countries have heavier weights in low valuation sectors and tend to have lower overall valuation multiples, it makes sense that at the country level, the value factor will do a better job picking winners if sectors with low valuation multiples outperform. CHART 15 Relative Strength Of Low Valuation Sectors Versus High Valuation Sectors CHART 16 Return Differentials Between Cheap Countries And Expensive Countries (Annual Returns) 14 THE GLOBAL IVESTMET PULSE, October, 2017 Valuation-Based, continued on page 14
Valuation-Based, continued from page 14 Investment Implications: After slicing and dicing the data, the big question is whether valuation can be used as a basis for country rotation or allocation, in either an Emerging Markets or Developed Markets portfolio. Based on the preceding analysis, here is our take: 1. Despite the cyclicality, over the longer term (1997-2017), investing in lower valuation countries ekes out better performance. Rebalanced monthly, a portfolio investing in the five lowest-price- To-Earnings Emerging Markets countries generated an annualized return of +19.2%, while investing in the five highest-price-to-earnings Emerging Markets countries generated an annualized return of only +5.7%. Over the long haul, overweighting cheaper countries might help Emerging Markets portfolio relative performance. Our study also indicates that the same value-based allocation strategy doesn t work for a Developed Markets portfolio, at least based on the data back-tested over the past 20 years. 2. Among the four valuation factors, Price-To-Earnings generated the largest cumulative return spread from 1997-2017. However, it was Dividend Yield that showed the most consistency in terms of factor effectiveness. As shown in Chart 16 at the bottom of page 14, from 2007-2017 when the other three valuation factors did not work, Dividend Yield continued to generate a positive return spread (cheap countries based on Dividend Yield outperformed expensive countries). For investors wary of factor performance volatility, Dividend Yield may be the best metric. 3. When we talk about factor cyclicality, we focus on the return spread between cheap and expensive countries. However, when looking at just the expensive countries, the pattern becomes more predictable. The five most expensive Emerging Markets countries have been persistently underperforming the equal-weighted Emerging Markets country benchmark (Table 1, below). Based on this backtesting result, one may be more confident by underweighting countries from the most expensive rank in an Emerging Markets portfolio. 4. The major effort of this follow-up study was to try to identify the underlying drivers for value cycles at the country level. The outcome is indecisive. evertheless, the back-testing data indicated that when Emerging Markets valuations, overall, are at generally low multiples, and when sectors such as Energy, Materials, and Financials start to outperform, then overweighting countries with low valuations appears to be a good tactic. Our analysis indicates that this is quite likely the condition of the current environment. However, due to the tight return differentials among countries (Chart 9), cheap countries may not be able to outperform by such a big margin as experienced back in 1997-2007. Source: This article was excerpted from Valuation-Based Country Selection/Rotation, by By Jun Zhu, CFA, Senior Analyst, The Leuthold Group, LLC (Perception Express, October 6, 2017), http://leuth.us/ stock-market COPYRIGHT 2017 THE LEUTHOLD GROUP, LLC REPRITED WITH PERMISSIO OF THE LEUTHOLD GROUP, LLC TABLE 1 Five Most Expensive Countries Underperforming Benchmark Top 5 Countries Rated Expensive By Period MSCI Equal Weight Benchmark Price-To- Book (PB) Dividend Yield (DIV) Price-To- Cash Flow (PCF) Price-To- Earnings Ratio (PE) 1997-2017 11.0% 7.1% 5.8% 6.0% 5.8% 1997-2007 20.6% 14.1% 14.5% 9.4% 9.9% 2007-2017 1.9% 0.2% -2.8% 2.7% 1.8% PULSE THE GLOBAL IVESTMET PULSE, October, 2017 15
SECULAR BEAR MARKET WATCH April 1, 2000 to September 30, 2017 (17 years and 6 months) Annual Compound Return Total Return Consumer Price Index (Inflation) 2.09% 43.41% 90-Day Treasury Bills Index-Total Return 1.56% 30.85% Barclays Aggregate Bond Index-Total Return 5.16% 140.36% High Yield Corporate Bond Index Total Return 9.08% 354.67% S&P Leveraged Loan Index Total Return 4.94% 131.62% HFRX Global Hedge Fund Index 2.48% 53.24% S&P 500 Index (U.S. Stock Market) 4.93% 131.53% MSCI EAFE Index (Developed Foreign Equities) 3.69% 87.95% MSCI Emerging Market Index (Equities) 7.36% 244.87% ewedge CTA Index (Managed Futures) 4.56% 117.37% Dow Jones UBS Commodity Index-Total Return (USD)** -0.87% -14.08% Dow Jones U.S. Real Estate Index-Total Return (USD)** 10.80% 497.39% Gold Bullion 9.37% 376.51% As of: September 30, 2017 Compound and Total Returns include reinvested dividends. MSCI Indexes do not include dividends prior to 2002. ewedge Index is equally-weighted. ** USD = U.S. Dollar COPYRIGHT 2017 LEGED FIACIAL ADVISORS, IC. Source: Bloomberg Investment Service REPRITED WITH PERMISSIO OF LEGED FIACIAL ADVISORS, IC. 16 THE GLOBAL IVESTMET PULSE, October, 2017
ote: During Secular Bear markets U.S. Stocks have historically returned a little more than inflation or a little less than inflation plus or minus 1.50% and generally last between 15 to 25 years. The last Secular Bear market (1966 to 1982) lasted 17 years and underperformed inflation by approximately one-half of one percent per year. The other Secular Bear markets since 1900 were 1901 to 1920 and 1929 to 1949. In both cases, the U.S. Stock market outperformed inflation by approximately 1.50% per year. All of the aforementioned performance numbers are pre-tax. The performance of the U.S. Stock market so far in the current period (April 1, 2000 to the present) certainly appears to indicate that we are in a Secular Bear market. Long-term returns (over the next 10 years) for the S&P 500 will probably be slightly worse than the last 17 years and 6 months. Current 10 year normalized P/Es (long-term valuations) indicate approximate annual compound returns of slightly less than 3.00% over the next 10 years. Of course during the next 10 years, returns during various periods will be significantly higher and lower than the expected return. For example, the more the stock market rises in the near term, the less returns after that period will be and vice versa. TOTAL CREDIT MARKET DEBT S (ALL SECTORS, AS A % OF GROSS DOMESTIC PRODUCT) POTETIAL IMPACT O GROWTH As of: September 29, 2017 COPYRIGHT 2017 CMG CAPITAL MAAGEMET, IC. Source: Bureau of Labor Statistics, Department of Commerce, Federal Reserve Board via CMG Capital Management, Inc., On My Radar, September 29, 2017, www.cmgwealth.com REPRITED WITH PERMISSIO FROM CMG CAPITAL MAAGEMET, IC. THE GLOBAL IVESTMET PULSE, October, 2017 17
2017 YEAR-TO-DATE PERFORMACE January 1, 2017 to September 30, 2017 (9 months) 2017 Year-To-Date Return Consumer Price Index (Inflation) 2.23% 90-Day Treasury Bills Index-Total Return 0.63% Bloomberg Intermediate Term Corporate Bond Index 5.10% Barclays Aggregate Bond Index-Total Return 3.14% High Yield Corporate Bond Index Total Return 6.11% S&P Leveraged Loan Index Total Return 2.98% HFRX Global Hedge Fund Index 4.43% S&P 500 Index (U.S. Stock Market) 14.24% MSCI EAFE Index (Developed Foreign Equities) 20.47% MSCI Emerging Market Index (Equities) 28.08% ewedge CTA Index (Managed Futures) -2.76% Dow Jones UBS Commodity Index-Total Return (USD)** -3.49% Dow Jones U.S. Real Estate Index-Total Return (USD)** 7.09% Gold Bullion 11.41% As of: September 30, 2017 Compound and Total Returns include reinvested dividends. ewedge Index is equally-weighted. ** USD = U.S. Dollar Source: Bloomberg Investment Service COPYRIGHT 2017 LEGED FIACIAL ADVISORS, IC. REPRITED WITH PERMISSIO OF LEGED FIACIAL ADVISORS, IC. 18 THE GLOBAL IVESTMET PULSE, October, 2017
THE STOCK MARKET MAY BREAK THE PATTER OF THE ULUCKY SEVES I 2017 By Doug Ramsey, CFA, CMT, Chief Investment Officer, The Leuthold Group, LLC Excerpted by James J. Holtzman, CFP, Legend Financial Advisors, Inc. and EmergingWealth Investment Management, Inc. The Dow Jones Industrial Average (DJIA) is close to evading the longstanding Unlucky Sevens curse in which the stock market has suffered a nasty second-half setback during each of the last 13 years ending in 7 ranging back to 1887. (In other words, one year ends in 7 every decade; therefore, over the last 13 decades.). This year, it s probable stocks will close 2017 at higher levels. If investors expect this Unlucky Sevens pattern to continue it would need to materialize fairly quickly. The so-called decennial (10 year) pattern calls for a sharp stock market drawdown contained within the fourmonth window extending from August 1 through ovember 30. For the last 13 decades any year ending in 7, the median (average) DJIA drawdown during this window has been an unlucky -13.0%. The DJIA has obviously bucked this pattern so far in 2017, suffering a mere 2.0% decline mid-august and entering month three of the bearish window at a new all-time high. Among the prior occurrences, the year 1927 likely provides the best analog to this year s action. That year, the DJIA fell 4.5% during the first half of August, soared to new highs over the next two months, and then suffered a quick 10.0% setback. However, those losses were mostly erased during ovember, and the market closed the year at a new bull market high (and all-time high). Source: This article was excerpted from Breaking the Pattern?, By Doug Ramsey, CFA, CMT, Chief Investment Officer, The Leuthold Group, LLC, (Perception Express, October 6, 2017), http://leuth.us/stockmarket ULUCKY SEVES? Dow Jones Industrial Average Daily Pattern During Years Ending In 7, 1887 to 2017 COPYRIGHT 2017 THE LEUTHOLD GROUP, LLC REPRITED WITH PERMISSIO OF THE LEUTHOLD GROUP, LLC Source: The Leuthold Group, LLC, Perception Express, October 6, 2017, http://leuth.us/market-internals REPRITED WITH PERMISSIO FROM THE LEUTHOLD GROUP, LLC PULSE THE GLOBAL IVESTMET PULSE, October, 2017 19
2017 LOWEST S&P 500 DRAWDOW YEAR EVER? Starting with 1914, we have EVER had a full year with an S&P 500 maximum drawdown as small as 2017. ever! 0.0% -10.0% -20.0% -30.0% -40.0% -50.0% -60.0% -70.0% 1914 1918 1922 1926 1930 1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 As of: October 2, 2017 Source: Josh Brown via Blane Rollins, CFA, 361 Capital, LLC, Weekly Research COPYRIGHT 2017 361 CAPITAL, LLC Briefing, October 2, 2017, www.361capital.com REPRITED WITH PERMISSIO FROM 361 CAPITAL, LLC MOTHLY RISK AVERSIO IDEX (RAI) RISK IDEX DECREASES TO EAR LOWEST LEVEL EVER ote: The Risk Aversion Index combines ten market-based measures including various credit and swap spreads, implied volatility, currency movements, commodity prices and relative returns among various high- and low-risk assets. 4 4 3 3 2 2 1 1 0 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: The Leuthold Group, LLC, Perception Express, October 6, 2017, http://leuth.us/bond-market 20 THE GLOBAL IVESTMET PULSE, October, 2017
LEGED FIACIAL ADVISORS, IC. & EMERGIGWEALTH IVESTMET MAAGEMET, IC. S IVESTMET MAAGEMET SERVICES Legend Financial Advisors, Inc. (Legend) and EmergingWealth Investment Management, Inc. (EmergingWealth) offer Personalized Investment Management Services to individuals and institutions. Investment portfolios are developed to match the client s return and risk requirements, which are determined by the clients completion of a Risk Comfort Zone Questionnaire, with the guidance of a Legend Wealth Advisor or EmergingWealth Advisor, respectively. Each type of investment portfolio is managed to achieve the short, intermediate and long-term investment objectives of the client, as may be applicable. IVESTMET PROCESS Investment Portfolios: Unlike most financial advisory firms that offer one style of investment or portfolio type, we offer a wide array of investment portfolios that usually fit with the large majority of client needs. If necessary, we will create customized solutions as well. For the types of investment portfolios, please see our Investment Portfolios, Potential Return and Risk Spectrum Chart on the next page. For a detailed description of our portfolios, please contact Louis P. Stanasolovich, CFP, founder, CCO, CEO and President of both firms for a confidential discussion at (412) 635-9210 or e-mail us at legend@legend-financial.com. Investment Research: Our Investment Committee performs extensive research to identify opportunities, mitigate risks and structure investment portfolios. Emphasis is placed on developing portfolios that maximize the potential return relative to the amount of risk taken. In-depth due diligence including face-to-face interviews in many instances with portfolio managers for open-end mutual funds is performed on each investment we select for a portfolio. Factors (both from a qualitative and quantitative standpoint) that we conduct a thorough analysis of each investment include, but is not limited to, liquidity (including the primary investment and/or the underlying investments, if utilizing pass through vehicles such as openend mutual funds or exchange-traded products), income taxation, all related costs, return potential, drawdown potential (historical declines from peak-to-trough), volatility and management issues (Anything having to do with the management team of a stock, open-end mutual fund or an exchange-traded product.). All portfolios for EmergingWealth are subadvised by Legend. Client Education: Education is very important to us. We are dedicated to educating each client about the different investment portfolio types and how they relate to market volatility, time horizons, and investment returns. It is our goal to ensure that the client understands and agrees with our investment philosophy. Furthermore, we assist each client in selecting a risk tolerance level with which they are comfortable. Ultimately, an investment portfolio is designed to meet the client s objectives. PERFORMACE REPORTIG Many investment firms only offer monthly brokerage statements, which provide minimal information; typically only account and investment balances. We, on the other hand, provide detailed quarterly reports that outline performance, income and management fees (among other items) in a simple, easy-to-read report. In addition, each performance report is sent with an extensive index page that illustrates the investment environment during the reporting period. FEES To find out more about the fees for either Legend or EmergingWealth s Investment Management services, please contact Louis P. Stanasolovich, CFP, founder, CCO, CEO and President of both firms for a confidential discussion at (412) 635-9210 or e-mail us at legend@legend-financial.com. THE GLOBAL IVESTMET PULSE, October, 2017 21
LEGED FIACIAL ADVISORS, IC. AD EMERGIGWEALTH IVESTMET MAAGEMET, IC.'S IVESTMET PORTFOLIOS, POTETIAL RETUR AD RISK SPECTRUM S&P 500 Risk LOWER RISK (COLD BLUE) MODERATE RISK (WARM) HIGHER RISK (BLAZIG HOT) ALL PORTFOLIOS ARE MAAGED BY LEGED FIACIAL ADVISORS, IC. High Quality 100% Equity For A Description Of Each Investment Portfolio Contact One Of Our Advisors Global Strategic Balanced 20.0% Equity 80.0% Fixed Global Strategic Balanced 30.0% Equity 70.0% Fixed Global Strategic Balanced 40.0% Equity 60.0% Fixed Global Strategic Balanced 50.0% Equity 50.0% Fixed Income The Portfolios In Red Despite Their Placement All Have Similar Potential Return And Risk Profiles Global Strategic Balanced 60.0% Equity 40.0% Fixed Income Global Strategic Balanced 70.0% Equity 30.0% Fixed Income Global Strategic Balanced 80.0% Equity 20.0% Fixed Income Legend Multi- Strategy 100% Equity Past Performance Does ot Guarantee Future Results Global Strategic Balanced 100% Equity Ultra- Speculative 100% Equity LOWER VOLATILITY RISK (VOLATILITY/STADARD DEVIATIO) HIGHER VOLATILITY 2014 Legend Financial Advisors, Inc. All Rights Reserved 2014 Legend Financial Advisors, Inc. All Rights Reserved LOWER POTETIAL RETUR HIGHER 22 THE GLOBAL IVESTMET PULSE, October, 2017