Letter to Our Clients – August 2019
August 28, 2019
As I write this I am 35,000 feet in the air, flying across North America and currently passing over the Chicago area. I am returning from Washington D.C., where I had the opportunity to volunteer with the Certified Financial Planner Board and a group of other Subject Matter Experts from around the country to assist the Board and their Council on Examinations in reviewing the CFP exam that prospective CFP professionals will be taking in November. With the goal of making the exam rigorous and professionally administered (similar to the bar exam for attorneys), our job was to work with testing professionals to review a part of the test (no one person is meant to see an entire exam, for security) for accuracy, relevancy, and consistency.
I have been called upon to volunteer on this project in a number of different ways over the last few years. Taking a few days to sit in a conference room to look over exam questions might sound boring upon first consideration. Considering that the CFP Exam that I had to take years ago was demanding and intensive, and required me to spend countless hours in class and studying, caused plenty of stress as I worked to internalize and memorize a wealth of information, and kept me from spending time and having fun with Lindsey on our weekends, some people have expressed surprise that I would want anything to do with revisiting that world of puzzling multiple choice questions. However, I have greatly enjoyed the experiences, and with every volunteer opportunity I have learned new information, met some very smart people, and have had a chance to collaborate and network with top financial planners from around the country.
As I have worked with others on the test questions, and as we share with each other best practices for running our respective financial planning firms, I have found it to be very interesting that there are substantial differences in our perspectives. While we all share similar fundamental values, we all have different business models, investment philosophies, communication styles with clients, and sometimes very different outlooks. At first glance some might find it odd or concerning that even assembled “experts” cannot agree on how best to practice financial planning, let alone how to best answer a certain test question on the CFP exam. However, I find it fascinating to hear many different points of view. For me it is always a helpful reminder to take a step back and check our assumptions, both in my work and in life in general, as overconfidence in our world view and being closed to new or different ideas is never a recipe for long-term success.
One topic in particular was much discussed in my recent session in D.C. As you may remember from our previous newsletters and client letters, we have been closely watching the “yield curve,” which is a measure of how the markets are viewing bond values and interest rates. Just recently, a closely watched part of the yield curve “inverted,” which basically means that investors demanded to be paid more (a higher yield) for shorter term bonds than for longer term ones. Normally, investors demand to be paid more for longer term bonds to compensate them for the risk and uncertainty that comes with not being paid back for a longer time. Imagine if your friend asked to borrow some amount of money from you. If she promised to pay it back tomorrow (and you trusted her!) you might be comfortable lending her the money for free, or for only a small cost. However, if she wasn’t going to repay you for 10 years, you might want a little more compensation for parting with your money for such a long time. In an inverted yield curve scenario, your friend would actually pay more for an overnight loan or a two year loan and less for a ten year loan, which defies common sense.
There are a number of reasons why the yield curve might invert, but much like the daily stock market fluctuations there are a myriad of forces that contribute to every change, and no one can know for sure why it moves the way it does. The yield curve is closely watched because historically an inversion has often preceded a recession in the economy, although a recession has come months or years after the inversion, so there is no direct “cause and effect” correlation. The fact that the yield curve does not normally invert, and that it has been linked to past recessions, led to a small panic in stock market the day of the inversion. As an aside, I was recently quoted in an article about what you should do about your investment accounts given all the recent “turmoil” in the stock market. You can read it here (https://www.marketwatch.com/story/the-market-is-acting-up-heres-what-you-should-do-about-it-2019-08-07?mod=alessandra-malito) if you are interested. I put “turmoil” in quotes because as of this writing the US markets are still within 5% of their all-time highs, and up well over 150% in the last 10 years, so despite what the financial headlines might read things are still looking pretty good.
Among our group at the CFP exam review, there was a wide range of opinions on the real meaning of this inversion. Some people felt strongly that it signals a coming recession, although even in that camp there was disagreement about what to do with that information, as there is no clear connection between inversions and lower long-term stock market returns. Others felt that the past connections between inversions and recessions were merely coincidental, and so this inversion was nothing but noise. Others felt that the historical correlation has been valid, but that things are different this time (for a variety of reasons) and so not much can be read into the recent news. As with so much in the financial world, there is no clear answer or obvious solution, even among the “experts.”
Here at Advanced Wealth Management, we have been telling you for some time now that we see reasons for concerns in the valuations we see in the stock and bond markets, and that any number of political, geopolitical, or economic surprises could send the economy and/or the stock market into negative territory. The recent yield curve inversion adds to our cautious outlook going forward. However, as you know, we firmly believe that major moves in the markets or economy cannot be consistently timed, and so making large changes based on your outlook is almost never a good idea, as I was quoted saying in the MarketWatch article.
Instead, we want you to be comfortable that your investments and your overall financial life are well-situated to benefit from the good times as long as they continue, and be well positioned for the downturn that we know will come eventually, all without losing sleep at night. The only reasons to make significant changes to the plan that we have crafted with you would be if your financial life has changed substantially, or if you feel that your tolerance for the uncertainty has declined since we last talked. And, if that is the case, then the time to make a change would be now when things are still good, and not when things have become scarier and your account balances are down. Most people have heard the expression “buy low and sell high,” but in reality it is one of the hardest financial behaviors to practice.
Thanks for your attention and for making it this far in a fairly dense letter compared to our normal communications. We hope that you found this useful, and if it raised any questions for you or if there is anything that we should be talking about, please don’t hesitate to reach out. We hope that you have been enjoying your summer, and that going forward you will be able to sleep soundly at night knowing that we are watching the yield curve, financial markets, and all the other aspects of your financial plan that we have built with you. Thanks again for the opportunity to work with you, and we will look forward to talking with you again soon!
Theodore Haley, CFP®, AIF®