2017 Third Quarter

Kreitler Financial:

Summer is upon us, and we’re certainly glad to have it. The various market indices continue to hit new highs, and the US economy continues to grow. Yet, we continue to hear a lot of unease and concern. In this letter, we will discuss why we continue to take a long-term view and counter some of the pessimism.

2016 was a year of political uncertainty. Elections in both the US and Europe threatened massive upheaval, and the press was filled with articles about populism and the “end of globalization”. Recent elections in Europe, especially France’s President Emmanuel Macron, have allayed concerns of the European Union fracturing. Now the political uncertainty has shifted to Washington. President Trump was elected with promises of sweeping changes to taxes, healthcare, and regulation. Major tax reform—perhaps even bipartisan, particularly on corporate taxes—seemed possible. This helped spark a huge rally in small company stocks shortly after the election.

2017 so far hasn’t seen much improvement with regard to getting clarity on politics and policy. Republicans are struggling to govern even with control of both chambers of Congress and the White House, and major legislation looks more challenging. Health care failed multiple attempts and the emphasis is now on tax reform. A fractious Republican caucus is having difficulty passing major legislation either on their own or with Democratic support. Easing regulatory burdens is happening quietly behind the scenes at the Executive branch, and this is helping to improve business confidence. We do not believe these changes are being recognized by the press.

In spite of the policy uncertainty, US and global stocks continue to do well, and the major asset classes have made money this year. From the beginning of the year through July, the S&P 500 climbed 10.3%. Smaller companies represented by the Russell 2000 index did not perform as well, climbing 5.0%, as hopes for regulatory and tax reform faded. Global stocks as represented by the MSCI EAFE rose 15.6%. Emerging markets, which sold off in 2016 on concerns about trade wars, have been the best performing stock segment with returns of 24.2%. The Bloomberg Barclays Aggregate Bond index had a modestly positive 2.7% return. The US economy continues to grow. Corporate profits continue to expand, which drives stock market returns. Is this because of Washington policy or in spite of it? We tend to believe it is due to the United States’ innovative economy and dynamic workforce.

Connecticut has its own series of challenges. The state is one of the few with net population loss. We hear from business leaders how challenging doing business here is, which affects job creation. The state government has its own problems as currently highlighted by the legislature’s inability to pass a budget. This is caused by years of politicians making promises they now find difficult to pay for. Government and charitable organizations that are dependent upon the state for money are now starting to feel the huge impact of this as their funding is drastically cut. Unfortunately, we think this is just the beginning. On a more positive note, from multiple sources we hear New Haven is doing better than other Connecticut cities.

Investors are able to tap economic growth outside their immediate home area. This is one of the benefits of owning stocks. However, the local economy most certainly weighs on one’s viewpoint of the world, so there is a risk of allowing oneself to become more pessimistic than is warranted.

Impact on Investing

Investors need to filter out both excessive optimism and pessimism so they can stick with a well-disciplined, long-term strategy.

Ultra-low interest rates continue to be a dominant theme in the investment world. Stock markets today are richly valued, but we continue to believe they will outperform fixed income over longer periods of time. The return that should be most important to investors is their after-inflation or “real” return. From 1802-2013, the real return on bonds has been 3.5%. In the same period, the real return on stocks was 6.7%.[BH1] In other words, after inflation stock returns over long periods of time have been approximately double that of bonds. With 10-year treasury rates currently at 2.3% and inflation at 1.6%, this may be even more so in the years ahead.

Over the long term how much you hold in stocks is a major determinate of how you do. Owners of stocks historically have been paid better returns than owners of bonds in part because they accept more risk. Stocks do have much higher volatility than bonds. Our most recent bout of downward volatility was from summer 2015 to February 2016, when the S&P 500 experienced a -14.1% return. Coincidentally, this is almost exactly the average market decline experienced every year[CK2] in the market. Markets decline more than that every three or so years, and this is completely normal. Investors who are able to ignore the daily headlines and ride through these difficult periods have historically been rewarded.

In the age of ultra-low interest rates, investors need to consider whether their portfolio mix is appropriate. Owning less stocks may reduce volatility, but has historically resulted in lower returns over long timer periods. In a low-rate world the effect may be even greater. Investors may need to lengthen their time horizons and accept greater portfolio swings to achieve returns above today’s bond rates. Maintaining an appropriate amount of money in liquid cash and bonds to address expected (and unexpected) portfolio distributions make it easier to weather difficult markets. If you have questions about your portfolio’s asset class mix, we would welcome a discussion with you.

A major financial planning implication of the current policy uncertainty in Washington combined with the longer term growing debt and future liabilities on entitlement spending is the potential for significant tax rate volatility. We expect to be spending time on these issues with our clients and accountant partners in the future.

Department of Labor Fiduciary Rule

On June 9, the DOL’s Fiduciary Rule went into effect. Based on the questions we receive, there is some confusion surrounding the rule.

The Fiduciary Rule requires that anyone providing advice for a retirement account like an IRA must act as a fiduciary, which in its simplest terms means “putting their clients’ interest before their own”. The rule requires that those advising retirement accounts must eliminate conflicts of interest, which generally means having compensation vary depending on which investments they recommend. Many investors had assumed that all brokers and firms were operating under a fiduciary standard, and they were surprised to learn that many operated under a different standard that allowed a broker or representative to consider their own compensation in recommending an investment product so long as the product met a lower ‘suitability’ standard for the investor. This is a bit like learning that your doctor prescribed the expensive name brand drug over the cheap generic because he or she received additional income from it.

Many firms are using the Fiduciary Rule as an excuse to reduce services or force clients into different fee relationships. Some find they cannot work under a more demanding fiduciary standard or the rule’s additional compliance and other requirements are too costly. Our clients know we have always worked under a fiduciary standard of care. This is since Bob became a CERTIFIED FINANCIAL PLANNER™ professional in 1989. Our relationship with you will not change, and we will continue to use cost-effective portfolios and provide comprehensive wealth management strategies. If you or someone you know has questions about the fiduciary standard or the impact of the new rule, we welcome a discussion about it.

Happenings at Kreitler Financial

We continue to invest both significant time and money to continually improve our client services and experience. Our team spent the first part of this year rolling out our new portfolio management software system from Envestnet Tamarac. The investment team is already using this powerful tool for portfolio management to increase the frequency with which we monitor our portfolios and our ability to fine tune them. Clients will get their first look at it this fall with the introduction of new consolidated statements and online reporting tools.

Our ability to coordinate and to manage investments at multiple institutions, including employer retirement plans, is very powerful and is uncommon among financial firms. As our clients know, we leverage this in a number of important ways.

  • Presenting an executive summary understanding of all portfolio assets for better coordination with life goals, maximizing the benefits of saving strategies, and generating tax efficient portfolio distributions.
  • Proactively managing current and future taxes using a number of strategies:
    • Evaluating and controlling the potential tax cost of every portfolio change vs. its benefit
    • Deferring taxes by holding select legacy investments with large unrealized capital gains, even if we do not currently recommend purchasing them
    • Using different types of accounts to hold each investment based on how it is taxed
    • Using tax-efficient investments in tax-aware accounts
    • Managing capital gains while still controlling overall portfolio risk by intelligently allowing asset allocation drift from portfolio targets
  • Diversifying a portfolio around a small selection of quality investment options offered in employer retirement plans by coordinating with accounts that have greater flexibility.

We strongly believe this helps improve portfolio and client outcomes. It requires that each client portfolio be permitted to hold a unique asset mix while still adhering to specific risk and return based asset allocation targets. Relatively few individual or professional investors are able to do this because of the complexity and cost to put these principals into practice.

Team development is an essential part of our culture. In April, a number of our team members attended the Raymond James National Conference for Professional Development, an opportunity to hear thoughts leaders present on a wide variety of topics and to interact with similarly minded professionals. Charlie attended the Raymond James Chairman’s Council Symposium in Chicago, an invitation-only event to exchange best practices with other top advisers.

Two of our team members had significant professional educational achievements. Both Beau Tillinghast and Jake Ness passed the challenging CFP Board of Standards exam requirement as they work toward the CERTIFIED FINANCIAL PLANNER™ certification. Please congratulate them if you have the opportunity to speak with them.

We take pleasure in marking life’s accomplishments and milestones. Our Chief Operating Officer Kim DiRaffaele celebrated her daughter’s wedding, her son’s high school graduation, and a housing move in the space of a few months.

Upcoming Events

Kreitler Financial is pleased to bring a very engaging speaker to New Haven this fall. Andy Friedman of The Washington Update will join us on October 24th for refreshments and an entertaining discussion about Washington’s evolving politics and policy, and the resulting impact that investors may expect. See attached bio for additional information on Andy. Invitations will be coming soon. Space will be limited, so please contact us if you would like to attend.

With warm regards,

Charles F. Kreitler, CFP®
Robert P. Kreitler, CFP®
Founding Partner

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Charles and Robert Kreitler, CFP and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell 2000 index is an unmanaged index of small cap securities which generally involve greater risks. The MSCI EAFE is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The MSCI Emerging Markets Index is designed to measure equity market performance in 25 emerging market indexes. The Barclays Capital US Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS. Inclusion of any index is for illustrative purposes only. Individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Past performance does not guarantee future results. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. RJFS does not provide tax advice. You should discuss any tax matters with the appropriate professional. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investments mentioned may not be suitable for all investors. There is no guarantee that any statements, opinions or forecasts provided herein will prove to be correct. Raymond James is not affiliated with Andy Friedman.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

[BH1] Source: AAII Journal August 2014 issue, interview with Jeremy Siegel, Professor of Finance at Wharton, on his book “Stocks for the Long Run”.
[CK2] If asked for a source, this is in a Nick Murray newsletter. We are not permitted to quote the newsletter, but we can use it to find his source. The Newsletters are saved under /library/investment newsletters/murray, nick/

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