When the Going Gets Tough: Remember the Long-Game

LiftingWeights

The recent stock market sell-off reminds us once again what a wild ride investing can be. Like death and taxes, precipitous market drops also seem to be one of those unavoidable, inevitable realities of life. But what we have observed, at least historically, is that markets have a way of clawing their way back.

No matter how much we may try to remind ourselves of this in the moment, watching markets plunge can be painful, even for the most seasoned investors. But if your savings are in a retirement account—with years of work still ahead, nearing retirement or even already retired—it’s important to keep the following four things in mind:

1. You are investing for the long-term

Don’t forget, retirement assets have a major advantage in the face of short term volatility—they are invested for decades. Seeing the value of your retirement assets fall may prompt you to take action, but selling may only lock in your losses—and attempting to time your way back into the market is never easy (all too often this can result in selling low and buying high). In fact, good and bad days tend to cluster together: out of the 25 worst days in the market from 1998-2017, 23 were followed by one of the 25 best days within one month[1].

2. At times like these, diversification can be your best friend

As Harry Markowitz once said, diversification “is the only free lunch in finance.” At no time does this hold truer than in periods of market stress. Having assets that “zig” when others “zag” can help increase portfolio stability and may help you lose less in a sharp downturn. Now is a good time to take a look at your portfolio—if your investments all go in the same direction at the same rate, it may be time to look at some diversifying investment options.

3. Cash has its place–in a savings account

If your retirement savings are invested only in conservative options (like cash or short-term bonds), your savings won’t have the opportunity to grow over longer time periods—and you run the risk that inflation will actually reduce the value of your portfolio. As an alternative, if you think you’ll need to access your money in the next year or two, consider building up a cash cushion separate from your long-term investments—such as in a high yield, FDIC-insured savings account.

4. Target date funds can help you better manage your market risk

Target date funds adjust the amount of risk your assets are exposed to over time—offering more risk (and growth opportunity) when you are younger with a longer investment horizon, and less when you are older and approaching—or are already in—retirement. By adjusting the trade-offs between higher return potential and downside risk management, target date funds can help better position you for a smoother ride throughout your career and in retirement.

Large market drops can rattle any investor, so it’s important to remember your long-term goals and stick with them—in up markets and in down. That’s why for many people, investing your retirement assets in a diversified, all-weather vehicle you can live with for the long haul can be the best strategy of all.

Paul Mele is the Head of Participant Engagement for BlackRock’s U.S. & Canada Defined Contribution (USDC) Group and a regular contributor to The Blog

 

[1] Source: BlackRock, with data from Morningstar as of 12/31/17

Investing involves risk, including loss of principal.

The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock, Inc. and/or its subsidiaries (together, “BlackRock”) to be reliable. No representation is made that this information is accurate or complete. There is no guarantee that any forecasts made will come to pass.

This material is provided for educational purposes only and is not intended to constitute “investment advice” or an investment recommendation within the meaning of federal, state, or local law. You are solely responsible for evaluating and acting upon the education and information contained in this material. BlackRock will not be liable for any direct or incidental loss resulting from applying any of the information obtained from these materials or from any other source mentioned. BlackRock does not render any legal, tax or accounting advice and the education and information contained in this material should not be construed as such. Please consult with a qualified professional for these types of advice.

©2018 BlackRock, Inc. All Rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

Emerging Markets’ Lost (Near) Decade

Turkey Skyline

U.S. technology is once again ascendant. Since the fall of 2016, the S&P 500 Technology Sector Index is up nearly 70%; the tech sector now accounts for more than 25% of the S&P 500 market capitalization.

Despite the strength of the recent rally, tech enthusiasts will recall a long, long period of unpopularity. After peaking in early 2000, the tech sector lost more than 80% of its value. It then took 17 years until the sector reclaimed its 2000 peak.

Investors in emerging market (EM) stocks should keep that history in mind as they go through a similar, albeit less prolonged drought. The MSCI Emerging Markets Index is trading at approximately the same level as it did in early 2010.

Value, or the lack thereof, played a part

Valuations in emerging markets never approached the Olympian heights that tech stocks traded at in the late 1990s.  That said, valuations have played a part in emerging markets’ struggles.

Since coming out of their own financial crisis in late 1990s, emerging market stocks have tended to trade in a well-defined range versus developed markets: a 45% discount to a 10% premium (based on price-to-book). Periods when EM stocks traded at a premium, such as late 2007 and 2010, turned out to be market tops. Interestingly, EM’s recent 20% drop was not proceeded by egregious valuations. In January, EM stocks were trading at approximately 1.9 times x book, a 23% discount to the MSCI World Index.

Another bottom?

Following the recent correction, EM stocks are trading at levels that preceded previous rebounds. EM equities are trading at roughly 1.55 times price-to-book (P/B), the lowest since late 2016 and a 35% discount to developed markets. Price-to-earnings (P/E) measures paint a similar picture. Current valuations represent a 33% discount to developed markets. Today, countries from Russia to South Korea are trading at less than 10x earnings.

Country Equity Valuations

Of course, valuations are never the complete story. In the short term, they might not even be that relevant. As I discussed back in August, an EM rebound probably requires two other components: a flat-to-cheaper dollar and signs of an economic rebound. On the former, emerging markets should be getting some relief as the dollar is now down nearly 3% from its August peak.

In terms of economic growth, the picture is more mixed. In late July it briefly looked like emerging market economies were growing faster than expectations. That rebound proved fleeting. Going forward, investors should focus on China, where efforts to accelerate the economy through monetary stimulus are accelerating. Typically, these efforts start to impact the real economy with a 1-2 quarter lag.

Continuing pressure on particular EM countries–notably Turkey and Argentina–are partially responsible for recent losses. Escalating trade frictions have not helped. Still, should the dollar remain stable and China begin to accelerate, valuations suggest the potential for a sizeable rebound.

Bottom Line

For investors who have given up on emerging markets, it may be worth recalling that nine years after peaking, U.S. technology stocks were still down nearly 80%. From there the sector began a rally that has lasted more than nine years and resulted in a gain of more than 500%.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal. 

International investing involves 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. These risks often are heightened for investments in emerging/developing markets or in concentrations of single countries.

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 September 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

More Myth Debunking

Federal Reserve Building

In a previous SMC FIM commentary, we attempted to debunk the “market timing” myth and presented evidence that showed investors actually lose valuable tax-exempt income by not maintaining a fully invested bond posture. This month we challenge the veracity of another widely held market myth:

“Fed short-term interest rate tightening results in equivalent higher long-term interest rates”

 Many investors mistakenly assume that short-term and long-term interest rate movements are linked through comparable yield movements. However, history disproves this notion.

  • During the last extended period of Fed rate tightening (2004-2006), the Federal Funds rate increased by 425 basis points; however, the 10-year U.S. Treasury yield experienced an increase of only 50 basis points.
  • During this time period, municipal bond yields, as measured by the Bond Buyer 20-Bond Municipal Bond Index, actually declined by 27 basis points. Historically, the movement in tax-exempt bond yields generally fails to match that of Treasury or comparable corporate securities.

We believe there is a good chance that history will repeat itself during the current phase of short-term rate increases. Why?

  • First, think about what long-term interest rates reflect: the expectation of future short-term rates plus a risk premium – the extra compensation for owning a security that will not pay off until sometime in the future. Investors should be paid for market uncertainty. Investing in U.S. Treasury securities does not present any credit risk, so the major risk factor is inflation.
  • As reflected by current bond interest rates, the threat of inflation continues to be constrained. Lack of significant inflation pressure should continue to subdue any meaningful rise in intermediate-term and long-term bond yields, even as short-term interest rates are managed higher by the Fed.
  • The goal under the current Fed program is to normalize interest rates and not to stem an imminent inflation threat. Today’s program is without historical precedent. So, the impact on long-term interest rates this time could be even more muted than what has happened in the past, causing a further flattening of the yield curve.
  • The impact within the municipal market is already being reflected in a flatter yield curve. We believe this is due in part to the significant reduction in net new tax-exempt bond issuance and an increase in retail demand due to changes to the individual income tax code such as the elimination of greater than $10,000 of SALT deductibility.

 

SMC Fixed Income Management (SMC FIM) is a municipal bond advisor and manager that provides customized municipal portfolios for individuals, trusts and estates through its Separately Managed Account Program, and provides advisory services to Unit Investment Trusts.

 

Disclosures

The information provided in this commentary is not intended to be a complete summary of all available data. Certain information contained herein has been obtained from published sources and/or prepared by sources outside SMC Fixed Income Management (“SMC FIM”), a division of Spring Mountain Capital, LP, and certain information contained herein may not be updated through the date hereof. While such sources are believed to be reliable, no representations are made as to the accuracy or completeness thereof by SMC FIM or any of its affiliates, directors, officers, employees, partners, members or shareholders, and none of the former assumes any responsibility for the accuracy or completeness of such information. Nothing contained herein shall be relied upon as a promise or representation as to past or future performance.

This commentary is neither an offer to sell nor a solicitation of an offer to purchase securities, any other investments or any other product sponsored or advised by SMC FIM, nor does it constitute an offer or a solicitation to otherwise provide investment advisory services. Such an offer or solicitation may be made only by the relevant documents for the relevant investment vehicle and/or investment program. This commentary is not, and may not be used as, a recommendation of any security, investment program or vehicle. There is no assurance that any securities discussed herein will remain in a client’s account at the time you receive this commentary or that securities sold have not been repurchased. The securities discussed do not represent the client’s entire portfolio and in the aggregate may represent only a small percentage of the client’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed was or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

Statements contained in this commentary that are not historic facts are based on current expectations, estimates, projections, opinions and beliefs of SMC FIM. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. Unless specified, any views reflected herein are those of SMC FIM and are subject to change without notice. SMC FIM is not under any obligation to update or keep current the information contained herein.

This commentary does not take into account any particular investor’s investment objectives or tolerance for risk. The information contained in this commentary is presented solely with respect to the date of its preparation, or as of such earlier date specified in it, and may be changed or updated at any time without notice to any of the recipients of it (whether or not some other recipients receive changes or updates to the information in it).

No assurances can be made that any aims, assumptions, expectations, and/or objectives described in this commentary will be realized. None of SMC FIM or any of its affiliates, directors, officers, employees, partners, members or shareholders shall be liable for any errors in the information, beliefs, and/or opinions included in this commentary or for the consequences of relying on such information, beliefs, or opinions.

Neither this commentary, nor any of the contents hereof, may be reproduced or used for any other purpose, or transmitted or disclosed in whole or in part to any third parties, in each case without the prior written consent of SMC FIM.

Copyright © 2018 Spring Mountain Capital, LP. All rights reserved.

Why Gold May Be Looking Cheap

The gold leaf. For the background and textures.

Of all the asset classes, commodities, particularly gold, are arguably the most difficult to assess. They are generally the most volatile. Moreover, the lack of cash flow makes them difficult to value; as a result, commodities tend to trade more on momentum. With that as a caveat, it is worth asking the question: Is gold beginning to look “cheap”?

I discussed gold recently in June and back in November. In both posts I suggested that gold would struggle with rising real-interest rates and a stronger dollar. The takeaway was investors should consider owning less gold than they typically would. While both rates and the dollar are still potential threats, according to one crude measure, gold prices may already reflect these factors.

Although commodities are notoriously difficult to value, there are ways to tease out an approximate range. As it applies to gold, one measure I’ve found useful is the ratio of the price of gold to the U.S. money supply, measured by M2, which includes cash as well as things like money market funds, savings deposits and the like. The logic is that over the long term the price of gold should move with the change in the supply of money.

Over the very long term this has indeed been the case. Gold’s value has risen, fallen and risen again, but over a multi-decade period gold and M2 have tended to move together. In other words, changes in gold prices have equaled changes in the money supply, with the ratio tending to revert to one. We can think if this as the long-term equilibrium.

Gold Money Supply Ratio

That equilibrium level is also relevant for future price action. When the ratio is low, defined as 25% below equilibrium, the medium 12-month return has been over 12%. Conversely, when the ratio is high, defined as 25% above equilibrium, the 12-month median return has been -6%. Today, gold is trading at a ratio of 0.73, i.e. 27% below the equilibrium level. This is the lowest point since late 2016.

Inflation is key

This measure can be refined further. Not surprisingly, gold tends to trade at a higher ratio to M2 when inflation is elevated. As many still view gold as an inflation hedge, investors are more inclined to buy when inflation is higher, particularly when interest rates are not keeping up with higher inflation.

U.S. inflation is still low by historical levels, but at 2.9% U.S. headline inflation is at its highest level since 2012. This supports the notion that gold looks relatively cheap. Based on this relationship, gold is approximately 10% undervalued.

Value, as I’ve said many times, is a poor short-time timing tool. To the extent the dollar continues to rise, gold is likely to struggle. That said, based on this metric gold is trading at the cheapest levels since the dollar last peaked in late 2016. To the extent it is even practical to discuss value and commodities in the same breath, gold prices are starting to look interesting.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

Investments in natural resources can be significantly affected by the events in the commodities markets.

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 July 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

 

Don’t Think About Your 401(k) in Isolation

Retirement Account

401(k) accounts can seem a bit strange. Unlike most other financial accounts where you can invest your money, your 401(k) account is tied to the company you work for. You can’t move your 401(k) account to a different financial institution (at least not while you’re still working for same employer) and (like many other types of retirement accounts) you generally can’t withdraw money from a 401(k) before the age of 59 ½ without incurring penalties. Yet just because your 401(k) account is different from other accounts doesn’t mean you should think about it in isolation.

If you have multiple accounts that you’re using to invest for retirement—whether they’re 401(k) accounts, IRA accounts, or regular brokerage accounts—thinking about each account as if the others don’t exist can be a mistake. Even if the allocation of your investments is reasonable in each account individually, it might not be ideal when your accounts are considered together. For example, a sizable exposure to a particular stock, fund, or sector of the market might not be a problem in one specific account. But if you have that same exposure across all of your accounts, it might put your ability to reach your retirement goal at risk.

Furthermore, only thinking about your accounts individually precludes some clever tactics that could help grow your wealth. If you’re investing for retirement with a mix of tax-advantaged accounts such as 401(k) accounts and regular taxable accounts, you might be able to use what’s called “asset location” to reduce your tax bill. Because income from different types of investments is taxed differently, the idea of asset location is to put more of the high-tax investments in the tax-advantaged accounts and the low-tax investments in the taxable accounts. Done properly, it can let you retain more of your wealth. But asset location requires that you think about your “retirement goal” as a single entity rather than as isolated accounts.

Technology “Bubble” Fears Don’t Hold Up

3D Rendering, old tv sets

Upon hearing of his obituary, Mark Twain famously quipped, “The reports of my death are greatly exaggerated.” A similar rebuke could be used for those claiming that technology stocks are back in bubble territory.

While technology stocks are having another stellar year in an otherwise languid market, their outperformance has been driven primarily through stellar earnings, not obscene multiple expansion. Since the start of 2010, the trailing price-to-earnings ratio (P/E) for the S&P 500 Technology Sector Index has risen approximately 20%, only slightly faster than the 14% for the S&P 500 Index. A quick look at top-line valuations confirms that 2018 is not the late ’90s redux.

1. Absolute sector valuation is below average.

At 23 times trailing earnings, the sector is trading at a discount to the long-term average of 28. To be fair, the long-term average is distorted by the bubble years, when the sector traded as high as 70 times earnings. Using the median, a statistical measure less influenced by outliers, suggests that today’s valuation is right in line with the long-term norm.

2. Relative value also looks reasonable.

SP500 Relative Valuation

The technology sector trades at an 11% premium to the broader market. While this is up from a couple of years ago when the sector traded at a small discount, the current premium appears very reasonable in light of recent history. Again, excluding the bubble years, the current relative valuation is actually a bit below the 15-year average (see Chart 1). Using cash-flow rather than earnings provides a similar picture: On a P/CF basis the sector is trading at about an 18% premium to the market, below the historical median of 30%.

3. The sector remains very profitable.

With a return-on-equity of 20%, the sector remains profitable relative to both its history as well as the broader market. The current return on equity is six percentage points above the broader marketThis compares favorably to the long-term median of around four percentage points.

Vulnerable to disruption

To be clear, every technology company remains vulnerable to being disrupted by a slightly more clever version of itself. A sobering reminder of this reality: On the eve of the financial crisis, Nokia’s smartphone market share was approximately 45%, the iPhone was less than one year old and Facebook was barely out of the dorm room. Pessimists will see this as a sign that the sector’s premium is unwarranted given the accelerating pace of innovation.

Although the pessimists have a point, the overall sector continues to be extraordinarily profitable, and, despite rumors to the contrary, reasonably valued. In an environment in which every company, in and outside tech, is vulnerable to being blindsided by an unheard of competitor or innovation, the tech sector is still delivering. It is worth a modest premium.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.  Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

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 June 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Money Is Still Cheap Enough to Support Stocks

Wooden economy and currency unit on a craft background; Shutterstock ID 121452739

Recently, U.S. interest rates hit multi-year highs and the dollar came back from the dead. From the February low to Monday’s high the DXY Dollar Index gained approximately 6.5%. At the same time, long-term U.S. interest rates are back to their early 2014 peak; two-year Treasury rates are at their highest level in roughly a decade. Together, higher rates and a dearer currency both represent a tightening of financial market conditions.

Still, despite these developments stocks have bounced, with the S&P 500 up 5% from the May low. How is it that stocks are rallying despite tighter financial conditions? Strong earnings are part of the answer. But apart from a stellar earnings season, the simple truth: Financial conditions have actually become easier in recent weeks.

According to two measures of financial conditions maintained by the Chicago and St. Louis Federal Reserve Banks, financial conditions have eased in recent weeks. There are three reasons financial conditions have actually gotten easier.

1. The dollar is still down year-over-year

While the dollar rally has been abrupt, it has also been short-lived. The dollar has advanced roughly 5% between mid-April and mid-May, but that rally only puts it back to where it was in mid-December. On a year-over-year basis the dollar is still down approximately 4% (see Chart).

Trade-Weighted Dollar

2. Credit conditions remain benign

Equity market volatility in February and March never did spread to credit markets. As a result, high yield spreads remain extraordinarily low, approximately 180 basis points below the 20-year average. Unlike during the growth scare in early 2016, credit markets have remained remarkably calm throughout the recent bouts of volatility.

3. Equity volatility has fallen

Although the February and March spikes in volatility were an “equities-only” affair, even that has calmed down. While volatility remains elevated relative to last year’s comatose levels, the VIX has “mean reverted,” or dropped back closer to average. Since the start of the month the VIX has averaged approximately 14. In comparison, implied equity volatility averaged 20 in February and March.

The resilience of equities

The fact that financial conditions have actually eased goes a long way towards explaining the resilience of equities. As I’ve discussed in previous blogs, the price investors are willing to pay for a dollar of earnings is in large part driven by the cost and availability of money, i.e. financial conditions.

Historically, easy financial conditions, particularly low volatility, have been associated with higher valuations. Depending on the exact measure used, in the post-crisis environment the level of financial conditions has explained between 25% and 35% of the variation in the S&P 500’s price-to-earnings multiple.

In other words, while U.S. stocks are still not cheap, a premium valuation is easier to maintain in a world of still cheap money and low volatility.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

International investing involves 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. These risks may be heightened for investments in emerging markets.

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 May 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts.

There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

3 Reasons to Stick With Emerging Markets

The Great Wall of China.; Shutterstock ID 439146580

For the first time since late 2016, emerging markets (EM) are under-performing their developed market counterparts. While few asset classes—outside of oil—are having a stellar year, EM is having a particularly bad time. An index of developed equity markets is roughly flat year-to-date; EM stocks are down approximately 2%. Emerging market bonds are having an even worse year, down more than 5%.

What’s going on? Is it time to lighten up on the asset class? The answer to the latter question is no.

A number of catalysts are to blame. Emerging markets are struggling with a sharp and abrupt reversal in the dollar, concerns about global growth and idiosyncratic issues surrounding particular markets such as Turkey and Brazil. That said, there are three good reasons to stick with the asset class.

1. The return of relative value.

Like every other asset class, EM stocks and bonds have been cheaper. However, recent weakness has restored relative value, particularly for stocks. Based on price-to-book (P/B), the MSCI Emerging Index is trading at a 30% discount to MSCI World Index of developed markets (see accompanying chart). This represents the largest discount since December 2016 and compares favorably with the 10-year average of 14%.

MSCI Emerging Markets Relative Value

2. Despite the typical first quarter slowdown, the global economy is in solid shape.

As I discussed back in late January, global economic growth is key for EM and I referenced industrial metals as a good real-time proxy for global growth. While softer in recent days, the JOC-ERCRI Metals Index has risen 20% during the past year and is still up 4% year-to-date. Other indicators of global growth, such as the global purchasing managers index (PMI), also confirm the ongoing expansion.

3. A stronger dollar is a headwind, not a death sentence.

There is no doubt that the rapid and surprising appreciation of the dollar has hurt EM assets. That said, the dollar is not the sole, or even primary determinant of emerging market performance. For equities in particular, changes in the dollar have historically had a modest impact on relative returns.

Expecting a better second half

While the past several weeks have been extremely unpleasant for EMs, there is reason to expect a better second half. The dollar’s sharp rebound is arguably the result of a rapid and violent unwind of a very crowded short trade. Recent changes in positioning suggest much of this adjustment has already occurred.

Beyond the dollar, the global economy should rebound this summer as the lagged impact of U.S. tax cuts and fiscal stimulus are fully realized. In particular, a likely acceleration in capital spending should be supportive of global trade, and by extension emerging markets. For investors who have already lived through the volatility, this is probably the wrong time to sell.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

International investing involves 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. These risks may be heightened for investments in emerging markets.

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 May 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts.

There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Swimming With Dolphins

Pier

Markets lately have resembled a dolphin at sea, leaping and diving in spectacular fashion. Observers often don’t know where to look for the dolphin next. In recent weeks, the same can be said of markets, leaping up at night before crashing down the next morning.

So how should you play these non-directional markets? In my opinion, you shouldn’t. Leave that to short-term traders and computer algorithms. But if your intent as an investor is to seek solid returns over the long term in order to pay future college expenses or fund a comfortable retirement, you need to ask yourself the following questions:

  1. Do headlines from Washington or Wall Street really matter? The answer, after years of sifting through empirical data is no. Headlines matter to voters, but rarely to investors. And in my view, they aren’t correlated with returns.
  2. Then what is correlated with long-term returns? In my experience it’s free cash flow generation and free cash flow yield.
  3. What drives free cash flow? To my way of thinking, free cash flow is driven by economic growth, margins, proper stewardship of capital and sound management.
  4. What other valuation metrics bear watching? The price-to-free cash flow ratio matters a lot, but in my view, so do the price-to-book ratio and the cyclically adjusted price-to-earnings ratio (CAPE), which are both quite rich too.1

Some perspective

Today’s headlines are awash with talk of trade wars and tariffs. Yes, tariffs matter, but only to certain companies and industries and to farmers of particular crops. From an economic standpoint, they don’t impact the market as a whole and aren’t of such a magnitude that they’ll end the economic cycle. The recently passed tax cuts alone dwarf all the tariffs being discussed, making the latest trade-related moves out of Washington look small by comparison.

As far as free cash flow generation is concerned, it’s off its record high per dollar put into the market, but is it going higher? Maybe. But my work shows me that future free cash flow generation is under pressure from rising labor outlays, higher borrowing costs and increasing general and administrative expenses. Free cash flow yield looks less promising at this point than it did during the spectacular rise we witnessed earlier in this long business cycle.

While the economy continues to grow and assets are still being used productively, there are signs that global economic growth may have begun to slow. In my view, economic growth is necessary, but not sufficient, for improved profits and cash flow. In order to continue to grow, cash flow companies need a decline in the cost of capital, steady-to-falling wages or a sizable rise in productivity.

So despite the recent market pullback, the price of entry into the market is still historically high, in my opinion. Consequently, in balancing risk and reward, it doesn’t make sense to be fully invested until risk asset price levels recede further.

So rather than chasing the dolphin — or the headlines — follow the cash flow while remaining cautious. If you are looking for a place to ride out these choppy market waters while awaiting more compelling equity valuations, the short end of the US investment-grade corporate bond market looks to be a less risky part of the market. Short-term high grade corporates have become relatively more attractive lately due to a number of technical factors, chief among them a one-time shift out of short-maturity corporate bonds as companies bring home cash held outside of the United States as a result of the recent tax act.

Price/book ratio (P/B) is the ratio of a stock’s price to its book value per share. The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, is a valuation measure usually applied to the US S&P 500 equity market. It is defined as price divided by the average of ten years of earnings (moving average), adjusted for inflation.

James T. Swanson, CFA is the chief investment strategist of MFS Investment Management.

 

The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.

Roth or Pre-Tax 401(k): 3 Questions to Ask Now

Eggs

More and more companies are offering their employees a choice of either pre-tax or post-tax (Roth) contributions within their 401(k) plans. According to a recent survey by Callan, the percent of retirement plans that offer a Roth option grew from 49% in 2010 to 71% in 2017.

But as with many aspects of investing, more choices can lead to confusion. If you’re faced with the choice between making a pre-tax or Roth 401(k) contribution, how do you know which one is right for you?

The question is especially timely now, when most of us are in the process of filing our taxes and many may be considering how to reduce their tax payments next year. And the recently passed Tax Cuts and Jobs Act makes the decision even more complicated, as tax rates will be changing from year to year as the new law is fully implemented.

Consider these three questions to help you decide:

1. Taxes – pay them now or pay them later?

Both Roth and pre-tax contributions offer the benefit of tax-sheltered growth while you’re working. When you contribute with pre-tax dollars, qualified withdrawals in retirement are taxed as ordinary income. By contrast, Roth contributions invest post-tax dollars, meaning qualified withdrawals come out tax free.

There are calculators that can help you determine the tradeoffs—check to see if your employer offers one on your plan’s website. But one of the most important variables is your estimated tax rate during retirement. If you think your tax rate will be lower in retirement than during your working years, it may make sense to go with a pre-tax contribution.

Alternatively, you might choose the Roth option if you expect your savings to generate a higher income in retirement than you currently take home. And remember, the total amount you withdraw in retirement will likely be greater than any amount you contributed, given the power of compounding returns.

2. Will your choice impact how much you save?

The choice between a Roth or pre-tax contribution will make a difference in your take home pay. All else being equal, when you make a Roth contribution, your take home pay will be lower than the same contribution made with pre-tax dollars. If a larger paycheck today will encourage you to save more than you would otherwise, you may be better off sticking with a pre-tax contribution.

recent study from the Harvard Business School, however, shows that most people contribute the same amount to a 401(k) regardless of which contribution type they make. This is likely because most of us invest based on a fixed percentage of our pay (such as 10%), rather than by trying to optimize both our take home pay and our retirement savings.

3. How important is future tax flexibility?

Perhaps the best choice you can make is to not pick one over the other, especially since future tax rates are hard to predict. If your employer offers both options, you can always divide your contributions between Roth and pre-tax. That can give you some tax benefit today while enabling you to diversify your potential sources of income—including how much is subject to tax—when you’re retired. Many financial planners refer to this as “tax diversification” and, like investment diversification, can pay dividends today and down the road.

Please note that regardless of which path you choose, any eligible employer match may be contributed pre-tax. Make sure to reach out your employer or recordkeeper for specific plan details.

Paul Mele is the Head of Participant Engagement for BlackRock’s U.S. & Canada Defined Contribution (USDC) Group and a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

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 April 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.