As we look on the year, we have seen several asset classes performing well. Bonds have shown positive performance and equity markets have been very strong. Alternative assets, like precious metals, have also had a strong year thus far. The chart below reflects the performance of several broad category ETFs on a year to date basis.

The above data also reflects the relatively disappointing performance in US Real Estate Investment Trusts, or REITs. Despite having more stock like risk and volatility, REIT returns have been closer to that of bonds than stocks. Based on the data below, we can see that long-term REIT returns are closely aligned to stock returns, and the underperformance has really been a function of the last year.

The information below reflects some of the reasons for the underperformance of REITs over the last year.

The anticipation of rising interest rates 

REIT performance is affected by the trends in interest rates. The reasons are two-fold. First, a significant source of the return in REITs is via the dividend yield. As coupon rates for bonds rise, investors can get higher income from their safer assets. This creates a negative effect for REITs as investors transition to safer assets to generate their needed income. Second, many REITs have long term contracts with their tenants and cannot pass through increasing debt costs, and as a result, are less profitable overall.

What has been surprising, is that while short term rates have risen, there has been a year to date decline in long term interest rates. The 10-year treasury has gone from 2.45% at the beginning of the year to 2.25% currently. Therefore, we have not seen the headwind of rising long term rates that would cause a drop in REIT performance. The market, however, tends to value securities based on what we expect to happen in the future. The consensus, while wrong thus far, still expects rates to rise in 2017 and into 2018. That anticipation of rising rates will likely act as a headwind for REIT valuations.

Concerns around pricing and square footage growth

REITs are primarily invested in real estate properties. To grow, they must fill the space they have, increase prices on their existing clients, and / or increase the amount of rented square footage. This requires an increased demand for square footage amongst tenants, and while that has been the case for industries like residential and industrial, other industries like retail have had more concerning trends on square footage. We have seen several store closures among large end and mall-based retailers over the last year as the percentage of shopping done online continues to increase. This has led to disruption among the retail based REITs as pricing and overall growth are called into question. As seen below, retail and mall focused REITs have performed very poorly during this period, and this has had a large effect on the REIT space overall as retail remains the largest percentage holdings of most common REIT indices.

Our position is that, despite the recent underperformance, REITs should still have a place in client portfolios. The reasons are:

• Diversification: REITs investments have lower correlations to US stocks and provide a diversified source of total return
• Income: US REITs are mandated to pay a large percentage of income back to shareholders. This creates long-term sustainable (and likely rising) source of income for clients
• Long term return: Per REIT.com, from the period of 1990-2016, REITs provided a compound average total return rate of 11.45%*

As with any asset class, there will be times where it is “in favor” or “out of favor”. Predicting when or how long an asset class will be in or out of favor is very difficult, and is precisely why we diversify.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Investors easily toss around the terms “value stocks” and “growth stocks”, but what do these labels actually mean?

Value investing refers to buying stocks that trade below the market averages and their own historical range as measured by price-to-book value, price-to-net asset value, price to earnings, or some other ratio integral to their business. Value investors tend to regard these calculations over market cycles, and make long term estimates of future growth, cash flows and earnings power. Different investors use different metrics, so there is also a second layer of value investing techniques: allowing a significant margin of error from the estimated intrinsic value. Value investors will buy stocks with the lowest current valuations and sell those with the highest current valuations, generally.

Put another way, value investors are buying a stock after others have lost confidence, when the stocks tend to carry lower risk than the market overall. These investors try to sell when the stock price has recovered and others have become euphoric about the stock’s prospects.

Growth stock investing, on the other hand, involves buying companies that have higher expected growth rates than the averages, with a strong cadence of sales growth and profitability. Companies are usually young, with a new technology or service that is expected to disrupt the status quo. These firms may not yet have earnings or generate positive cash flow. Cash is reinvested in people, equipment, facilities and/or research so the stocks provide no dividend yield.

Valuations such as price to earnings ratios are usually higher with growth stocks. Price/earnings-to-growth is an important measure since price to earnings alone does not easily compare with market averages.

Growth investors are searching for higher rewards, while taking on higher than average risks including but not limited to emerging competitive products/services, depth of management, decelerating revenue growth and/or accelerating costs or expenses. This higher risk is associated with better price performance when the general stock market is rising, and with underperformance when the general stock market is in decline.

At Gradient Investments we offer a U.S. value-oriented stock strategy, the G50. Over time it carries about 20 per cent less volatility than its benchmark, the S&P 500 index. We also offer the G33 stock portfolio which is U.S. moderate growth oriented and carries about 25 per cent more volatility than the U.S. stock market over time. The growth and value styles rarely perform in line at the same time, but overtime perform roughly the same. Therefore, investors in the G50 or the G33 should not expect them to outperform the U.S. market every year. We also offer an international value-oriented stock strategy, the G40i. Look at the images below to see how the U.S. and international value segments have performed over time.

U.S. Value and Growth Rarely Perform In Line

· In 2016 U.S. Large Cap Value (LCV) was up 17%, while U.S. Large Cap Growth (LCG) was only up 7%
· This year U.S. LCV is only up about 5% while U.S. LCG is up 18%

International Value and Growth Rarely Perform In Line

· In 2016 International Value was up 9.59% while International Value was up only 0.5%
· This year International Value is up 15.93% while International Growth is up 23.01%
Note the G40i inception date was December 31, 2016

When LCV outperforms the broad stock market we can expect the G50 and G40i to do well, and when LCG leads the market we can expect the G33 to do well. The investable universe of blue chip, dividend paying stocks that the G50 and G40i invest in are in the LCV half of the market. See the image below to see how the LCV and LCG sectors of the market are doing through August 31st, 2017:

As with any form of investing, there are various levels to value and growth which entail higher or lower volatility of stock prices. We remind you to know your risk tolerance score and continue to incorporate that into your investment plan. We don’t want to get into a cycle of selling under-performing portfolios and buying portfolios after they have outperformed. That cycle will destroy value over time. Stay with your financial plan, then permit time to work on your behalf.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Fundamentals drive market prices over the long-term. Things like corporate earnings, consumer confidence, employment, inflation, valuations, and economic growth matter greatly to the financial markets. There are times when political and geopolitical events can temporarily hijack markets. As the noise intensifies over Washington’s political agendas and national divisions, the market becomes more vulnerable to temporary price movements.

We experienced a spike in volatility in August and this scenario could repeat itself in the months ahead. Much of the so called, “Trump Rally” was based on expected pro-business reforms of lower taxes, better healthcare, fair trade and decreased regulations. The market loved the original message and is now in the process of distinguishing between hope and reality. While the media will do its best to sensationalize the struggles in Washington, the markets will ultimately respond to actual economic fundamentals.

Despite the uproar in Washington and tough talk on North Korea, the stock and bond markets took all the noise in stride producing flat to slightly positive results. Both emerging market stocks and the NASDAQ Composite were the best performing major indices this month posting 2.23% and 1.43% respective returns. Over the trailing 12-month period both had returns just north of 24%. The range of monthly returns was very tight as the worst performing indices (Barclays U.S. High Yield Bonds and international stocks represented by MSCI EAFE) both showed a minuscule decline of 0.04% in August.

In the U.S. stock market, winners and losers were determined either by industry or individual company results. The industry laggards were energy (again), healthcare and retail. Utilities, a long-time safe haven, had a good month supported by low interest rates and increased market volatility. Some second quarter earning disappointments severely punished some companies, while others had excellent results and were rewarded. Footlocker, Nike, Lowes, and Dicks Sporting Goods represented some of the retail carnage. On the flip side, companies like Norwegian Cruise Line, Blue Buffalo, Air Lease and Alibaba reported better than expected numbers and all reached new 52-week high share prices in August.

In the bond markets, interest rates stay low and credit spreads remain tight. This trend will continue into the foreseeable future. Economic growth would need to heat up into the 3-4% range to move interest rates higher. A major geopolitical event and or a serious stock market correction would be needed to jolt credit spreads wider. The current combination of low inflation, slow economic growth, and stable prices has the bond market in a very stable place.

Markets influenced by political events typically become buying opportunities. If the Washington rhetoric heats up and the fundamentals continue strong, averaging into a down stock market may offer a compelling proposition. If you are already invested at a risk appropriate level, avoid selling weakness and maintain the commitment to your long-term portfolio. Despite all the noise; people have jobs, the consumer is confident and willing to spend, and corporations are growing. This is a perfect foundation for success.

MARKETS BY THE NUMBERS: 

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222