If you like action, the first quarter was fast and furious. The stock market continued to find new highs on a daily basis with the Dow Jones Industrial Average surpassing 20,000 for the first time. Before the market caught its breath, the 21,000 level was shattered in just 24 trading days. Some of the air was let out of the balloon in March as the Federal Reserve raised the federal funds rate by 25 basis points and healthcare reform died in Congress, clouding the picture for future tax cuts.

The U.S. stock market has responded positively to a pro-business agenda emanating from the new leadership in Washington. With the backdrop of a growing economy, full employment, expanding wages, low inflation and a confident consumer, the promise of less regulation and lower taxes has fueled this market. While this formula brought us here, the question becomes, “Can the concepts be converted into policies and reality?” Stay tuned.

Stock returns were positive around the globe last quarter with emerging markets and international developed leading the way. International markets are becoming more attractive after under-performing the U.S. over the last 1, 3, 5 and 10 year periods. A recent acceleration in overseas economic growth is becoming reflected in their stock prices. The U.S. market found leadership in our old FANG (Facebook, Amazon, Netflix and Google) names and added another A for good measure (Apple). This group of stocks had an average return nearing 20% in just the first quarter. Energy was the primary laggard as oil prices found their way to just below $50 per barrel, down from a high of $56 in mid-February.

This is an interesting time for the bond market. The Federal Reserve is on a long overdue mission to raise short-term interest rates and return to a normal monetary policy. This will likely be the first year in the past ten where the Fed raises rates on multiple occasions. In addition to two or three more rate hikes this year, the Fed also must reduce their balance sheet by selling trillions of bonds they purchased during the multiple quantitative easing programs. This process will take years to unwind. We expect that interest rates will move higher at a glacial pace with the Fed deliberate and the economy stable.

Bonds traded in a tight range for the quarter with the 10-year U.S. Treasury reaching a peak yield of 2.62% and bottoming out at 2.31%. It closed the quarter yielding 2.40%, five basis points lower than where it began the quarter. Credit spreads also tightened a bit providing an incremental lift to bond prices this quarter. Investment grade spreads were 5 basis point tighter and high yield rallied 29 basis points, helping this sector outperform. It’s okay to own bonds for the basic reasons of income, principal preservation or volatility control, but temper your expectations for this asset class as we move through the year.

It is important to remember that markets move higher over time, but they do not move higher all the time. The first quarter was a solid one despite a slight pullback in March. We believe the markets are fairly valued here, but not overvalued. Stocks moving 5% higher from here by year end and bonds earning the coupon are reasonable 2017 expectations. Like 2016, there will be some bumps in the road. An employed and confident consumer in a lower tax world will lead the way to moderately higher stock prices. Stay invested and use any pullbacks as a buying opportunity.

The market has been on an impressive run recently. To review, as we neared the election, the S&P 500 had slid roughly 5% from recent highs and closed at 2,083 on November 4th. Since that time, the S&P 500 has returned 14.8% to close at 2,378 on Friday, March 17th. In today’s Market Reflection, we are going to analyze what has worked, and what hasn’t worked, during this period.

Sectors:
During this recent market rally, there has been a wide divergence of sector performance within the S&P 500. Financials and Industrials sectors have been leaders while Energy and Real Estate have lagged (see below chart). Financials performance has been tied to two factors: rising interest rates which tend to benefit banking and insurance companies, and sentiment that regulatory costs may be less of a burden with the newly elected administration. Industrials performance has been a result of improving fundamental and economic data combined with positive sentiment regarding potential enhanced infrastructure spending to accelerate GDP growth.

Sectors that have lagged the market include Energy and Real Estate. Energy performance has been hampered by a retracement of oil back below $50 amidst discussions of increased supply returning to the market. Real Estate underperformance can be explained by valuation in a rising rate environment. In a low yield environment, where investors are seeking income, Real Estate Investment Trusts (REITs) tend to receive a premium valuation due to their relatively high dividend payments. When interest rates begin to rise, REIT valuations tend to drop as investors transition to lower risk assets to generate their needed income.

Style:
The below chart reflects S&P 500 performance by style. As you can see, there hasn’t been a dramatic divergence of performance within the classic style segments of value and growth. Where we have seen a large style differential is the underperformance of high dividend paying stocks. According to the chart below, two large cap, high dividend ETFs (HDV and SPYD) have underperformed the overall market since the election. The issue for high dividend stocks is similar to the situation for REITs described above. As investors generate more income from bonds (through higher interest rates), there is less willingness to pay a premium for dividends generated through the stock market. This transition typically affects Real Estate, Telecommunications, Consumer Staples and Utility sectors the most. Most high dividend portfolios tend to have greater concentrations in these sectors compared to the overall market. Therefore, in a rising rate environment and an expectation of accelerated growth, it is fairly common for dividend focused portfolios to underperform the general market.

In conclusion, though we have seen very strong performance post-election, it is important to realize that this is a very short period of time for which to make broad conclusions. Sectors and styles are continually adjusting in and out of favor, and it takes a disciplined investment process to stay focused and avoid “chasing” short term trends that may erode long term performance.

At Nevada Retirement Planners, we design portfolios with long term objectives in mind using strategies that have been proven over several investment cycles. Each portfolio is designed with a core philosophy that is designed to meet a variety of client needs like principal preservation, income generation, or growth. Lastly, we use multi-portfolio solutions to generate diversified sources of return that meet client needs and are consistent with their risk tolerance and time horizon. If you would like to learn more, please give us at call at 775-674-2222.

Investors are familiar with the traditional stock and bond and alternative asset classes, typically choosing to buy individual securities. But what are exchange traded funds, and how do they provide exposure to these three asset classes? Why are they growing quickly, and how should they be utilized?

Exchange traded funds are low cost, pooled investment vehicles to enable diversified investment in a variety of stocks or bonds or alternatives. Most ETFs simply track an index, i.e., the S&P 500, the Barclays Aggregate bond index, the NASDAQ 100, gold, etc. to enable asset allocation among the major asset classes. ETFs are highly liquid; each can be bought and sold throughout a regular trading day.

From the original ETF created in the early 1990’s, there are now over 2,000 ETFs with combined assets of $2.8 trillion.* In fact, the dollars invested in ETFs has doubled over the last four years** and U.S. based ETF assets have grown by 30 percent while mutual funds grew just 3.5 percent in the last year.***

Why were ETFs created, and why are investors choosing to utilize them so widely? It was primarily growing dissatisfaction with high fees in the traditional mutual fund market that has driven more investors, individual and professional alike, to consider adding ETFs to their portfolios. Unlike mutual funds, ETFs have no upfront load charges, and their annual fees tend to be lower than many mutual funds.

In terms of new money added, the following chart indicates how ETF fund flows were invested during 2016:

Source: Investment Company Institute

ETFs can be used not only to replicate an index, but can also be used in actively managing portfolios depending on the investor’s preference for a particular slice of the market at any point in time.

Investors can choose a stock sector fund, i.e., materials, which will go out and purchase a pool of stocks in the materials sectors. The diversification allows for materials sector-type returns without single security volatility and risk. There’s an ETF for the stock markets of most countries around the world, and there are those which represent a region, i.e., Latin America.

Within fixed income, investors could choose Treasury inflation-protected bonds, emerging market bonds or a slice of less-than-investment-grade U.S. bonds via an ETF which could reduce risk within an otherwise volatile sector of the bond market (again without incurring single security risk).

The essential thing to remember about trading in ETFs is that it is imperative to understand what positions are held in each ETF in order to meet investing goals. While most ETFs incorporate over a dozen holdings, some include nearly 1,000. An ETF could contain a single security which accounts for a very significant portion. Some are routinely rebalanced to match a formula, i.e. the lowest volatility stocks in the S&P over the last 12 months, so reviewing those holdings from time to time is important.

With the proliferation of ETFs, there are more selections available for use within portfolios. At Nevada Retirement Planners, we believe ETFs offer an opportunity to cost effectively manage investments to meet our clients’ needs for protection of principal, income or growth across our Laddered Income, Absolute Yield, Endowment Series, Precious Metals and other strategies on an active basis.

Please contact us at 775-674-2222 to discuss how exchange traded funds may be applicable to your long term financial goals and objectives.

Sources: * XTF Research
** Barron’s 3/11/17
*** Investment Company Institute 2/27/17