SPRING 2018 | VOL. 25 | NO. 2 QUARTERL Y PERSPECTIVE 1. The Pendulum Swings... 3. Stock Performance...Rates (cont.) 2. Stock Performance in Times 4. From Which Account of Rising Interest Rates Should I Pay My IRA Fees? THE PENDULUM SWINGS… The market euphoria we experienced in January so far in 2018. The fear and uncertainty associated with stemming from recent tax reform (the Tax Cuts and rising interest rates, a growing U.S. deficit and recent trade Jobs Act signed into law on December 22, 2017), war concerns have investors pulling in their horns and quickly turned to pessimism as the Trump feeling more skeptical on full year earnings results. This is administration announced on March 1st the imposition neither unusual, nor unique to 2018; it has been part of the of tariffs on steel and aluminum imports. The fear of a market pricing dynamic from the very beginning. rapidly escalating trade war with China has caused However, this we do know: over time the market price will investors to question the staying power of the eventually follow the direction of earnings within this fear/ synchronized global economic rebound that began in greed bandwidth. Continued on page 4 the fall of 2016. With nearly half of the earnings of the S&P 500 attributable to foreign revenues, these are PRICE/EARNINGS MULTIPLE [EXPANSION & CONTRACTION] legitimate concerns, but it is still not yet clear if this SS&P&P 550000 % CChangehange approach is simply a negotiating tactic or new U.S. YYearear P Pricerice E EPSPS P P/E/E S S&P&P 550000 E EPSPS P P/E/E international trade policy. ''0000 $1 $1,320.28,320.28 $56 $56.78.78 23 23.3x.3x ''0101 $ $1,148.081,148.08 $47$ $47.4947.49 2 24.2x4.2x ( (13%)13%) ( (16%)16%) 44%% ''0202 $879 $879.82.82 $50 $50.51.51 17 17.4x.4x ( (23%)23%) 6 6%% ((28%)28%) The Impact of P/E Multiple Expansion & Contraction ''0303 $ $1,111.921,111.92 $55$ $55.2355.23 2 20.1x0.1x 2 26%6% 9 9%% 1616%% With earnings of the S&P 500 Index projected to climb ''0404 $1 $1,211.92,211.92 $68 $68.80.80 17 17.6x.6x 9 9%% 25 25%% ((13%)13%) ''0505 $ $1,248.291,248.29 $78$ $78.5678.56 1 15.9x5.9x 3 3%% 1 14%4% ((10%)10%) by nearly 19% in 2018, investors are in a quandary as to ''0606 $1 $1,418.30,418.30 $90 $90.06.06 15 15.7x.7x 14 14%% 15%15% ((1%)1%) how stock prices can be in swift decline while near term ''0707 $ $1,468.361,468.36 $87$ $87.4587.45 1 16.8x6.8x 4 4%% ( (3%)3%) 77%% corporate earnings prospects appear to be so bright and ''0808 $903 $903.25.25 $73 $73.70.70 12 12.3x.3x ( (38%)38%) ( (16%)16%) ((27%)27%) ''0909 $ $1,115.101,115.10 $61 $61.95.95 1 18.0x8.0x 2 23%3% ( (16%)16%) 4747%% D positive. My response is simple: sometimes it is not so ''1010 $1 $1,257.64,257.64 $87 $87.02.02 14 14.5x.5x 13 13%% 40 40%% ((20%)20%) much the earnings of a company, but what an investor is ''1111 $ $1,257.601,257.60 $98$ $98.8998.89 1 12.7x2.7x ( (0%)0%) 1 14%4% ((12%)12%) ''1212 $1 $1,426.19,426.19 $105 $105.21.21 13 13.6x.6x 13 13%% 6 6%% 77%% willing to pay for the projected earnings. As an example, in ''1313 $ $1,848.361,848.36 $111$ $111.29111.29 1 16.6x6.6x 3 30%0% 6 6%% 2323%% both 2016 and 2017, as the globe was awash in central ''1414 $2 $2,058.90,058.90 $118 $118.89.89 17 17.3x.3x 11 11%% 7 7%% 44%% bank liquidity, investors bid up the price of U.S. common ''1515 $ $2,043.942,043.94 $118$ $118.59118.59 1 17.2x7.2x ( (1%)1%) ( (0%)0%) ((0%)0%) ''1616 $2 $2,238.83,238.83 $119 $119.16.16 18 18.8x.8x 10 10%% 0 0%% 99%% stocks. Nearly half of the % gain in the broad market was '17'17 $ $2,673.612,673.61 $133$ $133.08133.08 2 20.1x0.1x 1 19%9% 12%12% 77%% driven by a rising P/E multiple, increasing from a 17x ''18*18* $2 $2,640.87,640.87 $157 $157.78.78 16 16.7x.7x ((1%)1%) 1919%% ((17%)17%) multiple to over 20x by year end 2017. The inverse is true * 3/31/2018 S&P 500 Price and Consensus EPS Estimates Source: Factsett Brian Christensen, CFA 2 3.35 19.29 13.92 (6.59 Senior V ice President & CIO STOCK PERFORMANCE IN TIMES OF RISING INTEREST RATES Beginning in 2008, in response to MONTHLY AVERAGE CHANGE IN S&P 500 DURING PERIODS OF RISING 10-YEAR TREASURY YIELDS the collapse of financial markets, the Federal Reserve initiated a period of 2.5% extremely accommodative monetary policy. The Fed Funds target rate 2.0% e entered 2008 at 4.25% and finished g 1.9% n 1.5% a the year at 0.25%. For more than h 1.5% C 1.0% 1.3% seven years, historically low interest % 0 rates were maintained and proved to 0 5 .5% 0.8% be a driver of higher prices for all P & types of assets. The Fed managed to S 0.0% 6 YearsY assure significant liquidity was -0.5% -0.1% -0.5% available in financial markets thus encouraging investors to assume -1.0% 0% -3% 3% - 4% 4% to 5% 5% to 6% 6% - 7% 7% + greater risk as that was the only route 10 - Year Treasury Note Yield Source: Standard & Poor’s as of December 20, 2017 to reasonable investment returns. In So what does this mean for stock rising rates, particularly if initiated late 2015, the Fed signaled the end of investors? History has proven that from a low base. Historically, until this policy cycle by bumping the Fed stocks can move higher in tandem the 10-Year Treasury yield reaches Funds target rate to 0.5%. We have with rising interest rates. However, a the 6% level, stocks have been able seen five additional increases to the key issue is the initial level from which to generate positive monthly Fed Funds target rate since late 2015 interest rate increases begin their average returns. reaching the current level of 1.75% on ascent. The chart above provides a Digging a little deeper into the March 21, 2018. While interest rates perspective on how the S&P 500 data, we identified six specific time are far from excessive or stifling U.S. responds to increases in the 10-Year periods when the 10-year Treasury economic growth, the message from U.S. Treasury Yield. yield was climbing. the Fed is clear in that the path for As implied by the chart, stock interest rates is higher. prices should respond favorably to Continued on page 3 US 10Y T-Note Yield (TPI) Monthly 2.75 - 0.04 -1.53% 9:5555:04 AM VWAP US 10Y T-Note Yield (TPI) - Price High: 9.32 Low: 1.45 Chg: 67.91%- 10 9 8 7 6 5 4 3 2.75 2 1 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 Source: FactSet 3 CONTINUED FROM PAGE 2 : STOCK PERFORMANCE IN TIMES OF RISING INTEREST RATES The table on the right identifies RISING RATE WINDOWS – STOCK PERFORMANCE those six windows and the respective returns for the S&P 500, Index 1993 1998 2003 2009 2012 2016 S&P 500 – Dividend Payers, and Starting 11/01/93 11/01/98 07/01/03 01/01/09 08/01/12 08/01/16 large value stocks as measured by the Ending 01/31/95 02/29/00 07/31/04 04/30/10 12/31/13 02/28/18 Russell 1000 Value Index. With the exception of the S&P 500 TR USD 3.35 19.29 13.92 (6.59) 25.75 17.45 November 1998 to February 2000 S&P 500 – Dividend Payers 4.75 (0.97) 22.40 (1.28) 30.56 14.61 timeframe (recall these dates as the Russell 1000 Value TR USD 0.66 3.01 17.81 (7.77) 27.98 12.56 Tech Stock Bubble), both Value stocks and Dividend Payers performed well Source: FactSet relative to the broad market. raises in June, September and interest rates should be tolerated by The Fed Funds futures market December. Moderate, well equity markets. Despite what appears currently indicates a 60% probability communicated increases in to be a return to more of another 0.25% rate normal market increase in either volatility, we believe June or August the underlying and a 42% strength in the U.S. probability of an economy and additional 0.25% continued growth increase in either in corporate September or earnings will November. Many provide the basis economists are for improving predicting a total stock prices. of four increases in 2018 which would suggest possible MIKE FLAHERTY, Relationship Manager In February, Mike Flaherty joined the firm as the newest Relationship Manager in the Peoria, IL office. Mike brings to DVI over 15 years of experience in the financial service and insurance industries, where, as a financial advisor and operations manager, he proved himself as an effective leader.