Returns for the major stock indices for the third quarter of 2017 and the current bond market yields are as follows:
|Dow Jones Industrial Average||13.37%|
|Fixed Income Yields||1 year||5 year||10 year||30 year|
As you have seen in your monthly statements, the markets continue to deliver increases in asset prices. While we hesitate to use loaded language, we recognize the markets have been very good to long-term equity investors. The markets have plodded along in an upward trend quite systematically in 2017. In many of our previous letters we have written about reasons to stay the course, emphasizing long-term results while advocating the words of Warren Buffett several times. Our portfolios have never been higher and we acknowledge the good times are here; however, we have also been around the block a few times and know that markets do not rise in perpetuity without pauses, corrections or price adjustments.
It is often said that “hindsight is 20/20,” implying that everything looks clear upon reflection. We do reread our previous quarterly letters and attempt to take inventory of how we have navigated the markets and how our advice has fared over the 23 years since our inception. We could highlight that we have often understood the current market conditions at the time, alluding most specifically to the late ‘90s when we wrote about excessive stock prices during the tech bubble as well as the inflated housing prices in the mid-2000s. These were two of the most difficult times over the last two decades that led up to the challenging markets we all experienced. While we attempt to recognize impending headwinds, it is how we steward our way forward that is most important. So with hindsight clear, the ever-pressing questions are where are we now and what should we do?
The forward-looking questions posed above are always difficult, but do not stop us from pursuing answers. Certainly we cannot address your situation specifically in this letter, but we can speak to where our most ardent discussions are now. We believe the most significant outlier in today’s investing world worth mentioning is the continued historical anomalies in bond valuations and interest rates as a whole. Many of the most respected minds have voiced concerns including bond king Bill Gross and former Federal Reserve chairman Alan Greenspan, who both have used language such as “bond bubble.” We continue to be concerned with high bond prices and our bond holdings reflect these sentiments. The current interest rate environment has created much angst among the investing community. The search for yield (interest/dividends) has had individuals and money managers scrambling for non-conventional investments; hence, we caution against the flavor of the times – alternative investments; this is code for digging for yield in a magic box. We have not been opposed to using a non-traditional method to attain yield. We have successfully used a utility-stock model as a bond substitute for several years, though we concede this alternative option is significantly less attractive going forward as the dividend yields are considerably less than historical averages.
While we agree with the experts mentioned above, we offer a simpler view of how to view bond prices in today’s world. The 30-year Treasury bond currently yields 2.86% and a 10-year yields 2.33%. By committing new money to these bonds you accept paying 35 times earnings (in the case of the 30-year bond) and 42 times (in the case of the 10-year) for a guaranteed yield less than inflation while being taxed at the ordinary income rates and with minimal chance for price appreciation. We certainly would never buy an equity under these conditions. Moreover, the money pouring in to bond funds (ETFs and Mutual Funds) vs. equity funds since the end of the Great Recession is astonishing (1.7 trillion into bond funds vs. minus 458 billion from stock funds). As we have written before, we are in a 35 year bond market rally and very few investors and money managers have invested in a rising interest rate environment.
While we agree that rates and bond prices are distorted, we remind those with bond positions that your bonds will mature and your entire principal will be repaid. There is a myriad of explanations for why bonds have been in such demand but it does not mean they are attractive investments for those interested in growing their assets. We know that ultimately this money will come out of bonds and in to more attractive opportunities. Our stock models that include blue chip holdings like McDonalds, Procter & Gamble and Johnson & Johnson all have dividend yields greater than the 10-year Treasury, have increased their dividends annually for several decades and have prospects for price appreciation. So, while we know equity investing demands discipline and perseverance and has been the best asset class over any reasonable amount of time, we look forward to the day we can return to more conventional asset allocations. For now, we are still not comfortable with alternatives to equities.
We genuinely appreciate your business and value the trust you have placed with us in the stewardship 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