Returns for the major stock indices for 2016 and the current bond market yields are as follows:
|Dow Jones Industrial Average||+16.50%|
|Fixed Income Yields||1 year||5 year||10 year||30 year|
As we close out 2016, long-term equity investors have,once again, been rewarded with double-digit returns. As we reflect on the year, 2016 endured more market-moving drama and bouts of fear related to geopolitical events. The beginning of 2016 gave us a 10% pullback in the market related to uncertainty with the Chinese economy; in late June, we experienced a brief 5% sell-off from Brexit; in November, the U.S. election gave us another specific date of perceived reckoning or opportunity which had investors from both sides of the political aisle unsure of how to invest. These three market-moving situations gave shortsighted investors cause to worry, but provided long-term investors great opportunities to invest and be rewarded.
At LYNCH & Associates, we regularly discuss what it means to be a long-term investor. We believe it starts with the correct mindset: you have to believe that when you are buying ownership in a company in the form of stock that you are buying the rights to the dividends and appreciation of the company. Because you will collect dividends from your company (typically four times a year) and have the opportunity to realize capital appreciation, there is a market value on these rights and opportunities. The investor’s dilemma becomes, “What is an appropriate price you should pay (stock price) to receive these dividends while weighing the opportunity for price appreciation?” The opposite of this mindset, which we hear often, is one of “playing” the market as if stock prices are based on nothing; that valuations in equities do not reflect anything other than global news headlines or whims from a newsletter selling doom. If your mindset is the latter, we believe you will underperform long-term investors over time.
We often remind our clients that the stock market averages three 5% pullbacks per year, one 10% correction per year and a 20% correction every three to four years. We have seen these market declines over and over; they are almost always associated with a story of fear and never feel good if you have your eyes glued to your account; trust us, we feel it as well. With this said, we also remind our clients that on average four out of five years the market is positive and that a stock market increase of 30% or more occurs an average of every four years. Allow us to firmly say, it is these big market years that can add significant gains to your net worth. If you are shortsighted and attempt to time the market, we have seen repeatedly that you are left behind by your fellow long-term investor.
As for 2017, we believe there are many reasons for investors to be positive; perhaps, most notably, is tax reform. If the corporate tax rate comes down from a global-leading 35% to 15%, much of the estimated two and a half trillion dollars overseas will come back home in the form of stock buybacks, higher dividends, and capital investment. We also agree that reducing regulations on the financial industry will have a positive effect on the economy, allowing banks to increase credit to consumers and grow their own balance sheets through more attractive credit spreads. Moreover, with consumer confidence at a 15 year high and the prospects for lower income taxes, we would expect to see increased consumer spending and better earnings in 2017.
We are cautious of the bond market. It is important to remind our investors that the U.S. has been in a 30 year bond market rally and we have watched interest rates decline over that time. As a result, many investors and financial advisors have not had the experience of investing in a rising interest rate environment. We believe this creates hazards for bond investors; specifically, investors in bond funds. Since the presidential election, bond prices have declined about 5%; we know this prompts questions to advisors about why bonds are going down.
At LYNCH & Associates we buy only individual bonds that mature, as we say, at 100 cents on the dollar. We avoid bond funds because we know the yield advertised can be misleading, as expensive bonds can be placed in the fund to make the yield look more attractive, and that a fund cannot always hold their underlying bonds to maturity. Consequently, if rates were to rise rapidly, redemptions in these funds would cause further damage to the net asset value of bond funds. Also, remember that interest rates can and will move independently of the Federal Reserve; ultimately, bonds and their rates move on the supply and demand for the particular bond. If you wish to discuss this further, please let us know.
We genuinely appreciate your business and value the trust you have placed with us in the management of your financial assets. As always, we welcome and encourage you to schedule an appointment to review your personal financial situation.
Ryan T. Lynch, CFP® ChFC®
Form ADV Part II of the LYNCH & Associates Uniform Application for Investment Advisor Registration and the LYNCH & Associates Code of Ethics are available to all clients at any time. If you would like to receive a copy, please contact Jennifer Farless at (812) 853-0878 or jfarless@LNAonline.com.
Office: 10644 Newburgh Road, Newburgh, IN 47630