Market Commentary

The market dip (a percentage decline of -5.0% to -10.0%) that began in August has endured as high interest rates, consumer spending, and economic growth concerns investors. The month of September returned -4.94% for the S&P 500, -5.79% for the NASDAQ, and -3.74% for the Dow Jones Industrial Average. Despite the recent volatility, the S&P 500 and NASDAQ are still posting double digit gains from January through September.

When looking more closely at the numbers, what is interesting is how seven technology stocks are responsible for the vast majority of index returns. More specifically, market leaders including Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta account for roughly 28.0% of the S&P 500 Index weighting and have contributed nearly 65.0% of the S&P 500’s gain. This type of outperformance, attributed to a rally in Artificial Intelligence and the respective technology stocks future earnings potential, causes room for caution and opportunity.

Valuations among these market leaders are at historic highs. When valuations are high, their future expected returns drop. Since stocks often revert to the mean, this sign of caution creates an opportunity for rebalancing.

Over the past year we have taken this opportunity to reduce our exposure to such growth and technology-related companies to diversify portfolios more broadly into value-oriented companies. We have also increased exposure to small and medium-sized companies because they are historically undervalued when compared to large companies. Over a longer period, this type of rebalancing can help reduce volatility in the short-term while providing greater returns in the long-term.

Just as this year’s top seven companies have led the pack to the market’s July 31st peak, they have also led the way down over the past two months. As such, we remain vigilant by evaluating opportunities in the bond and equity markets as conditions evolve and asset classes become more favorable.

This year’s rally in the stock market has been welcomed with open arms after last year’s challenges. Thus far, we have seen the market rally from the beginning of the year through its current peak on July 31st. During that time frame the S&P 500 gained 19.5%, the NASDAQ 36.5%, and the Dow Jones Industrial Average (Dow) 7.5%. However, since July 31st these market indices have fallen off their highs and were down roughly 5.0% (From July 31st to August 17th the NASDAQ was down 7.9%, the S&P 500 was down 4.6%, and the Dow was down 3.0%).

What we experienced is called a market “Dip.” A “Dip” is defined as a percentage decline of -5.0% to -10.0% which occurs roughly 3 times a year and has an average length of 46 days.

So, what has caused the market dip?

Since the beginning of August, it has become more apparent that the federal funds rate (now at 5.25 – 5.50%) will remain higher for longer to combat inflation. Over much of the year, expectations were for the Federal Reserve to cut interest rates as early as the third or fourth quarter of 2023. However, inflation (3.2% in July) remains above the Federal Reserve’s target of 2.0%. As a result, the Federal Reserve has provided commentary that they are “prepared to raise rates further” should inflation remain above their target.

Consequently, we have seen the market adjust to economist expectations for interest rates to remain higher for longer and to begin to fall at least once through the middle of 2024.

In addition to fighting inflation in the US, economic issues from China have become more visible. From rising unemployment among their youth, to uncertainty in their real estate sector and overall growth, the slowdown of the world’s second largest economy has a global effect.

As concerns mount from the Fed’s monetary policy, a slowdown in China, and more, we continue to monitor your investments daily and are poised to act. More specifically, we intend to further diversify our bond positions (if applicable to your portfolio) by increasing our overall credit quality. Similarly, we remain selective when adding to our overall equity exposure given market valuations and other factors. Remember, even amid market uncertainty, investment opportunities exist, and we are confident in helping you navigate the current investment and economic environment.

The events that have unfolded recently in the banking sector have investors on edge as market volatility has increased.

The first part of this commentary is a summary of a couple of banks that have been shut down or rescued. I included this information because there has been a lot of speculation about what has happened. While more information will come out about what has taken place, this provides an overview of what we know at this time.  

What Happened?

Silicon Valley Bank
Silicon Valley Bank (SVB) is a bank that primarily dealt with technology companies. SVB invested deposits in assets such as U.S. Treasury Bonds during a time when interest rates were at historical lows. During 2022, interest rates jumped significantly and quickly caused unrealized capital losses on their bond holdings. Recently, there were significant withdrawal requests of approximately $42 billion due to technology firms needing more liquidity.  SVB had trouble meeting those requests because of the capital losses. Most deposits were corporate monies and the majority of holdings were uninsured because the balance of the accounts were above the Federal Deposit Insurance Corporation (FDIC) limit of $250,000.00.

Signature Bank
Signature Bank was shut down because depositors withdrew billions of dollars as a reaction to SVB being shut down.Signature Bank had significant exposure to cryptocurrency companies, although that is not cited as a reason for the significant withdrawals.

First Republic Bank
First Republic Bank also had a significant number of uninsured deposits and started to experience a great deal of depositor withdrawals.  In addition, First Republic had a large book of real estate and there were concerns they could not cover many withdrawals. Eleven large U.S. banks provided a $30 billion cash infusion into First Republic to shore up the bank and as a sign of confidence in the banking system.
 
What Happened to Uninsured Deposits?
The FDIC, Treasury Department, and the Federal Reserve said they would cover uninsured deposits of SVB and Signature Bank.

What are the Concerns?

1. The primary concern right now is whether there are any other banks that face financial trouble that could result in more bank failures or a more systematic financial crisis.
2. Any concerns that banks have about their capital or deposits could lead to less lending that will slow down the economy.      

What Has Legend Done?

1. Anytime we adjust the investment portfolios, we focus very closely on how much exposure we have to any sector, including financials. We set target percentages of ownership in specific sectors and asset classes to provide diversification to our clients’ portfolios and to not have too much exposure in any given sector or asset class.
2. Except for our most aggressive portfolios, the bulk of our portfolios use mutual funds and exchange-traded funds which own numerous equities, bonds, and other securities which provides a more diversified holding than an individual stock.
3. In our most aggressive portfolios, we use individual stocks along with ETFs and some mutual funds.  We have strict disciplines in place to not allow a stock to become too large of a position in the portfolio. We also limit exposure to any specific sector such as financials.

What Will Legend Do?

1. We will continue to review your investment portfolios daily and monitor your investment allocations.
2. We will remain diligent monitoring the Schwab Value Advantage Money Fund (SWVXX) and their underlying holdings. SWVXX’s portfolio has most holdings that have a maturity between 1-7 days. SWVXX’s portfolio is a majority of U.S. Treasury and Government Agency Repurchase Agreements, Certificates of Deposits, and Commercial Paper, which is short-term debt issued by corporations. This money market fund has been yielding approximately 4.50%.
3. We will continue to explore other investment opportunities to further improve your portfolio’s risk profile.

What Should Clients Do?

1. Please do not hesitate to contact us if you are concerned about your portfolio or have questions about the current situation with the banks. We are here to provide support during these times of increased market uncertainty.
2. Ensure that you have less than $250,000.00 in an FDIC-insured U.S. bank. While uninsured deposits have been protected with Signature Bank and SVB, there is no guarantee that will continue to be the case.
3. Stay focused on the objectives of your financial plan. It is very difficult to predict how the markets will react over the short-term. However, over the long-term, meeting your financial goals is still the main objective.

We will continue to monitor future developments related to this and continue to keep you informed about any changes that we will be making. We appreciate your trust in us.

To keep you informed about the decisions of our Investment Committee, we are including a summary about a recent change to our education plans.

For our clients with Bloomwell Nebraska 529 Education Savings Plans, we have recently made a few changes. We can make two allocation changes per year and recently implemented our first change of 2023. With debt (bond) funds becoming more attractive in the current interest rate environment, we have moved a portion of money from the money market mutual fund to higher-yielding debt (bond) mutual funds.  We have also made a concerted effort to align the equities in these Nebraska 529 Plans with a more balanced investment style, focusing on diversity across the sector, style, and size of the equity positions. Overall, these changes should potentially provide a better risk-adjusted return for the portfolios.

The Bloomwell Nebraska 529 Education Savings Plan is unique because it allows us as the advisor to select the investment allocations enabling more diversification compared to an index-only based savings plan. For any client with interest in starting an education savings plan, we encourage you to inquire more about this option by scheduling a meeting using the Calendly links below.

Meeting with Jim Holtzman

Meeting with Bill Knight

Legend Adjustments – Money Market Fund

To increase returns during the current economic environment, we have recently purchased a Money Market Mutual Fund to replace the cash positions in our clients’ portfolios.  Money Market Mutual Funds invest in high-quality, short-term money market investments issued by U.S. and foreign issuers.  Unlike cash, Money Market Mutual Funds participate in rising interest rates while not sacrificing stability and liquidity of capital.  At the beginning of the year, they were earning roughly 0.10%.  Now, since interest rates have gone up, the money market funds we have purchased are earning approximately 3.50%.  Although Money Market Mutual Funds are very safe, they are not FDIC insured.  However, they are insured by the Securities Investor Protection Corporation (SIPC).  Unlike the FDIC, which protects if banks fail, SIPC protects customers if the brokerage firm fails financially but does not cover losses due to market fluctuations.  Coverage is up to $500,000.00 for securities per account type at each brokerage firm, including a maximum of $250,000.00 in cash.  Additionally, TD Ameritrade and Pershing each provide more than $100 million worth of protection for securities and $2 million of protection for cash for each client through supplemental coverage.

Please Note: Due to Money Market Mutual funds being tradeable securities, we will need an additional day to prepare any distributions.

Legend Adjustments – Bonds

For our clients with bonds allocated in their portfolios, we have recently made a few changes.  We sold our position in the Loomis Sayles Senior Floating Rate and Fixed Income Fund (LSFYX) and purchased the DoubleLine Total Return Bond Fund (DBLTX).  About half of our bond allocation remains in Floating Rate funds, and the other half is now in Total Return Bond funds.  Total Return Bond funds have become more attractively priced as interest rates have increased.  Overall, these changes should provide a better risk-adjusted return.

Last Week: Interest Rate Update

This past week, The Federal Reserve (Fed) raised the Federal Funds Rate last week by 0.75% to a range of 3.00% to 3.25% (highest since 2008) and made it clear that additional interest rate hikes are coming. The stock market did not react favorably to this announcement even though it was expected. As a result, the S&P 500 revisited bear market territory (20.0% drop from recent high) while the NASDAQ revisited a severe bear market (30.0% drop from recent high). The market is back to the lows that were visited in June, 2022.

Bear Market Rally:

The market had a rebound from June, 2022 until August, 2022. This is what is known as a bear-market rally. A bear-market rally occurs when the market increases in price after a major drop in the stock market occurs only to have a subsequent drop to new lows.  Bear-market rallies are not uncommon, nor is the retesting of prior lows.

Impact Of Interest Rate Increases On The Stock Market:

Traditionally, the beginning stages of the rate-hiking cycle produces the most negative market performance. The beginning of the rate-hiking cycle was in March, 2022 and the Fed has increased interest rates five times this year.

Generally, market performance becomes more favorable as the interest rate-hiking schedule is ending. The current expectation is that the Fed will increase the Federal Funds Rate to 4.00% - 4.50%.

Historically, market performance is strong in the year after the Federal Reserve stops increasing interest rates.

The Fed typically shifts to a more accommodative stance as economic conditions weaken and inflation moderates. Thus, signs of a recession, while unwanted, could enable the Fed to pivot later this year or in 2023, which we believe could be a positive for market performance.

Legend Investment Decisions:

We continue to evaluate all the investments in our clients’ portfolios daily while looking for new investments to introduce to the portfolios at opportune times. In general, we have been adding equity investments to the portfolio over the past year and a half that are cheaper than the stock market and/or have low correlations (how investments move in relation to the other) to the investments in the portfolios. We have also been able to mitigate the significant losses that have occurred in the traditional bond markets.

Overall, we have been trying to balance the mitigation of downside risk in our client portfolios while providing upside potential for when the markets begin to rebound.

Personalized Discussion:

It is very important for our clients to stick to their financial plans while realizing that this type of downside volatility is not unusual.  If you want to revisit your investment goals and your financial plan, please contact us as we want to reinforce and accomplish your long-term objectives.

Over the past few months, our Investment Committee has implemented portfolio changes with the goal of reducing the overall risk of the portfolios while capitalizing on attractive investment opportunities.

We have included a few insights on recent changes as well as a vision for the portfolios moving forward.

Please note that the changes listed below will not apply to all portfolios.

Legend Adjustments – Bonds

We sold the Nuveen Floating Rate Income Fund (NFRIX) in order to diversify our overall bond exposure and reduce risk should we enter a more prolonged downturn.  Floating rate funds like NFRIX have been one of the best performing asset classes this year.  However, if we are to experience further downside, floating rate funds could experience volatility.  As a result, we decided to add a more traditional bond mutual fund called PIMCO Total Return (PTTRX).  Since we have experienced what is likely to be the peak of inflation and long-term interest rate increases, more traditional bond funds like PTTRX may offer a more attractive risk-to-reward profile when evaluating the portfolio as a whole.

Legend Adjustments – Equities

Where possible, we harvested tax losses on the SPDR Consumer Discretionary ETF (XLY), and added to, or initiated positions in the Invesco S&P 500 Equal Weight Consumer Discretionary ETF (RCD).  Historically, companies in the consumer discretionary space have positive performance as inflation begins to decline.

Another area of the market that became more attractive from a valuation standpoint is Biotech.  We added the SPDR S&P Biotech ETF (XBI) in our more aggressive portfolios.  Similarly, value companies remain one of the more attractive investment areas.  We continued to increase our allocation to large cap value through the Schwab Fundamental US Large Company Index ETF (FNDX).

More recently, we added the Leuthold Core ETF (LCR) to increase our equity exposure.  This fund is well diversified, giving us upside potential should the market rally, while offering attractive downside protection if we see economic deterioration.

We also allocated available cash to underweight positions in our portfolio’s small cap exposure through Virtus KAR Small-Cap Growth Fund (PXSGX), Driehaus Small Cap Growth Fund (DNSMX), and the Vanguard S&P Small Cap 600 Value ETF (VIOV).  Where applicable, we made purchases to bring these positions to their target weighting given a pullback in the small cap asset class, and due to historically attractive valuations.

Lastly, in the stock portfolios, we have added a handful of companies as the downturn in the first half of the year created more attractive entry points.  We will send a separate E-mail to the client’s who have these portfolios.

Potential Changes

Over the next few months, we intend to add to our debt and equity holdings.  We continue to evaluate more traditional bond funds to balance the debt portion of our portfolios. On the equity side, we continue to look for asset classes that are attractive from a historical perspective, such as Emerging Markets.

Closing

Despite historically high valuations and challenging economic conditions, we are confident with our portfolios should we experience more volatility.

We appreciate your feedback and your confidence in us as we navigate this investment environment.

Our Investment Committee is providing a Market Commentary to our clients.  We intend to provide our clients with more Market Commentaries as important events come up in the markets and the economy.  We also will use this forum as we are making changes to client portfolios to keep our clients more informed about what our reasoning is for changes we have made and what our vision is moving forward.  This Market Commentary is a bit longer than we anticipate in future Market Commentaries as we are covering activity that has taken place since the beginning of this year.

Volatility

The equity markets continue to endure a lot of volatility and the past couple of weeks have been no exception.  Almost all sectors of the equity markets are in negative territory this year.  For the week ending May 27, 2022, the Dow Jones Industrial Average broke an eight-week losing streak, while the S&P 500 and NASDAQ Composite broke a seven-week.

Russia’s invasion of Ukraine has increased volatility this year, but volatility was already increasing due to inflation concerns and the Federal Reserve increasing short-term interest rates. Volatility has also increased as the world is still suffering from supply chain issues and China’s Zero-Covid Policy only increases this problem.

What has complicated matters is that the bond market is off to its worst start to a year in history.  Normally, bonds cushion some of the negative equity volatility.  However, with long-term interest rates increasing due to inflation along with the Federal Reserve increasing interest rates, the bond market is having a terrible start to the year causing a real surprise for traditional investors.

Legend Adjustments – Bonds

For our clients with bonds allocated in their portfolios, we have most of the fixed income or bond allocation in floating rate funds to significantly mitigate interest rate risk.  Interest rate risk is the risk of interest rates rising, causing fixed interest rate bonds to decrease in price.  The floating rate funds we are using mitigate interest rate risk because the interest rates adjust with the market.

While the 20-year U.S. Treasury Bond is down over 20.0% year-to-date, the floating rate funds in our client’s portfolio are down between approximately 2.5% and 3.5%.  Last year, U.S. Treasury Bonds were down mid-single digits and the floating rate funds were positive between 4.00% and 7.00%.

In March, 2022, we sold the Amplify BlackSwan Growth & Treasury Core ETF (SWAN) and in May, 2022, we sold the Alphacentric Income Opportunities Fund (IOFIX) because they were causing more volatility than we wanted in the bond allocation of our client portfolios.

Legend Adjustments – Equities

For our clients with equities in their portfolio, we have made the following adjustments.

In April, 2022, we reduced the investment allocation to the tech heavy Invesco QQQ Trust Series ETF (QQQ) and the iShares Semiconductor ETF (SOXX).  We concluded there was a need to reduce these positions due to the substantial gains that both funds achieved over the last several years and were becoming too large of a percentage of the portfolio.

In Mid-April, 2022, we purchased the iShares US Insurance ETF (IAK), and the Schwab Fundamental U.S. Large Company Index ETF (FDNX).  We wanted to acquire large cap value exposure in the portfolio along with additional value investment allocation in general.

Value investments tend to perform better in a rising interest rate environment while growth investments typically do not perform as well.  Another way to look at these moves is that we took profits from very expensive areas (growth investments) to purchased parts of the market that are much cheaper (value investments).

In May, 2022, we locked in some gains by selling portions of Barclays Bank iPath Bloomberg Commodity Index Total Return ETN (DJP) and SPDR S&P Metals & Mining ETF (XME) given the sizable positive performance this year and we were concerned that some of the run-up in price was due to the war in Ukraine and the price could drop just as quickly as it rose if circumstances change in Ukraine.
  
There are several investments performing very well this year and are in positive territory while most market sectors and investment styles are negative for the year.  This includes DJP, iShares Gold Trust (IAU), and XME.  The increase in energy prices has helped DJP, which has exposure to oil and natural gas.

This past week, we completed our due diligence on a managed futures fund and purchased the American Beacon AHL Managed Futures Strategy Y (AHLYX).  Managed futures have a very respectable track record of not being correlated to the stock market.  As a result, this type of investment has the potential of reducing volatility while still increasing the expected return of the portfolio.

We have been carrying a higher cash position than normal.  This has been an active decision as the markets got off to a poor start at the beginning of the year and the higher cash position has helped reduce volatility in the portfolios.  This is not a long-term decision and we will invest this money strategically over time.

Potential Changes

We are considering to add a position in a more traditional fixed interest rate bond fund.  While the bond market has been terrible for the last 17 months, there is a case to be made for adding this type of investment to the portfolio due to interest rates having increased which makes traditional fixed interest rate bonds less expensive and can potentially cushion any further downturns in the equity markets.

We are also considering the addition of an asset allocation fund and are starting the due diligence process.

None of these moves are final yet and may not occur, but we wanted to make you aware of what our Investment Committee is considering moving forward during these volatile times in the market.

We appreciate your confidence in us as we navigate this current investment environment.