On Wednesday, 4 of the most powerful CEO’s in the tech industry spent five and a half hours testifying in front of Congress. CEO’s from Google, Apple, Facebook and Amazon were questioned by Congress.  The reason they were called before Congress is to address accusations that these four companies are stifling innovation and crushing their competitors before they even have a chance to compete.  The chairman of the anti trust panel, Rep. David N. Cicilline (D-R.I.) accused these companies of creating monopolies in their industries and drew comparison to John D. Rockefeller and Andrew Carnegie.  They called out the CEO’s for acquisitions they have made throughout the years to eliminate competitors. This may not be the end of these hearings for the tech companies as they may be called back to testify again on a future date. 

With this backdrop the big tech companies reported earnings Thursday after the market close.  The earnings reports for Apple, Amazon and Facebook smashed estimates and each stock in premarket trading are up 5% or more.  The success of Amazon was strongly on display last quarter as the company grew both sales and profit. The 5 largest tech stocks now make up around 25% of the S&P 500.  This is why many analysts refer to the market as being heavily concentrated with big tech carrying the overall market.  Here is a chart of how these stocks have performed against that benchmark since last year.

After the bell today, Amazon beat the top line expectations by $8 billion, and Apple reported its highest third quarter revenue ever, growing 11% y/o/y. The fundamentals are justifying their massive growth.

Apple Stock Split

During the earnings call the board of directors at Apple approved a 4-1 stock split.  That means that for every share of Apple stock that an investor owns they will receive 3 more additional shares.  The stock price before the market open is trading above $400 that means that the new price of the stock will trade around $100.  Share holders can expect to see these changes in their account on August 31st.

To discuss what this could mean for your portfolio or a review of your investments Click Here

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Emergency Fund:

The volatility in the stock market, job layoffs and furloughs, unexpected expenses. This year has led to a lot of uncertainty for many Americans.  This has also shown us the need to have some cash set aside in case we have future emergencies. An emergency fund is a readily available liquid source of assets that can be used during times of financial distress.  Liquidity refers to how quickly you can convert those assets to cash that can be easily used for those unexpected expenses. Having money set aside to handle life’s curveballs are essential for your finances and to keep you out of missteps that could have long term ramifications.  The times when an emergency fund are found useful are: loss of a job, home or auto repair, medical emergency or an unexpected worldwide pandemic such as the Coronavirus(sounds crazy). 

Where can you put the money?

The most common place to put your money for use in case of an emergency is a checking or savings account. You want to make sure that whatever account you are using is separate from your everyday operating account. Also, this account should have a layer of difficulty that makes it not easily accessible.  Remember, a new pair of shoes or a flat screen tv that is on sale is not an emergency.

There is now a plethora of online banks that offer compelling benefits for placing the money with them. Traditionally, these banks are not as well-known and tend to pay a higher interest rate to earn your business. These accounts are known as high yielding, however, with the interest rate environment the way it is today these banks have had to cut their interest rates which have made them less appealing. The second item to look for when selecting a bank to hold your emergency fund is the impact of any fees. Most banks will charge a monthly fee if your balance is below a certain amount or if you do not have direct deposit setup on your account.  Be aware and make sure to select a bank that will not nickel and dime your emergency savings. Nerdwallet put together a list of good places to look that may have higher than average interest rates, the list can be found here.

Make sure that the money in your emergency fund is not invested.  This money needs to be easily accessible and available to be withdrawn the same day you need it.  Stocks, mutual funds and ETF’s should be avoided because of their appetite for risk and fluctuations that occur due to the market.  Also, CD’s are one of the last places you would want to place emergency fund assets because of the fee for early maturity.  Make sure that your money is in cash or a money market when you are building and sustaining your emergency fund.  Let me know if you would like some information on cash equivalents and the rates they are currently paying.

How much should someone have saved?

This question is different for everyone and there is no one size fits all solution. The typical rule of thumb that you may hear from Dave Ramsey is 3-6 months living expenses saved in cash. Dave also suggests that if you have bad debt, such as credit cards, that you have a beginner emergency fund will $1,000 saved. Most people have a “sleep well at night” amount that they like to see if cash and for the most part that could be used to cover an emergency.  Here are some factors to consider when deterining what about you need to have set aside in an emergency fund. Are you a one income or two income household, obviously a 1 income household will need to have more saved in the case of an emergency.  How quickly can you find a job? This is something that few can truly answer but there is an easy way to gauge this.  Ask people in your network or look around on LinkedIn to see if you are marketable and if finding another job would take little time.  One strategy you could use is however many months it will take to find a job, that is the corresponding amount you would need to have monthly expenses saved in an account.  Medical history, age of household appliances and state of your current automobile are all things to consider when determining how much to have saved in an emergency fund.  When dealing with an emergency your spending should only be on essential items.  Therefore, take time to examine your budget and see what expenses you can get rid of in times of a crisis.

Here are 4 quick ways to earn some cash to start building up an emergency fund.   

            For retirees and preretirees an emergency fund is different than the money you will have set aside for living expenses.  Although the money you have set aside will be in conservative investments or cash this is not to be used as emergency funds.  The money in your portfolio that you are conservatively investing is designed to cover ordinary living expenses, with that in mind you will still need to keep cash set aside in case of an emergency that can bring on unexpected bills. 

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The recent rally over the past two months has been something that has a lot of investors scratching their heads. Even with the tsunami of bad news, April and May were the two best consecutive months for the stock market since 1987.  The market is forward looking, therefore,  trying to time the market or waiting for “things to blow over” before putting money back into stocks oftentimes causes investors to miss the best days or months in the stock market.  So how has the market performed in May and for this year so far, take a look at this chart.

The recovery of the overall market has been led by the tech stocks holding their value and even increasing by over 9%, as shown by the return of the Nasdaq 100.  However, by looking at the S&P 500 Value index, those stocks are still down over 14% Year to Date.  We have seen a resurgence in value stocks in the trading days this week.  This is mainly caused by the reopening of the economy and many believe the rally in these stocks still has room to grow.  The value companies are heavily reliant on a growing economy and I believe we will start to see growth again by this fall.  This year financial stocks are still down double digits Year to Date, the low interest rate environment has hurt these companies, but as the economy reopens the financial sector could once again return to levels we saw earlier this year.  Adding an increase allocation to these value stocks and also small cap U.S. stocks is a good tactical shift to make over the next couple of months.  As the U.S. economic picture improves, adding exposure to small caps as well could lead to significant upside over the upcoming months.  Making these tactical rebalances to your portfolio can help to increase your chances that you are selling high and buying low.

As you can see from the chart above small cap stocks are still down sharply on a year to date basis. These companies have been hit hardest by the shutdown in the U.S. economy. Making a tactical shift to these sectors can help to boost returns over this next quarter. Historically small cap stocks have lead the market coming out of a bull market. We have not seen the surge in prices thus far but that could change over the coming months.  These stocks are still well below their 10 year annualized average return.

This rebound in stock prices has made investors feel uneasy and the recency the decline in stocks has many believing stocks will drop right back down to those levels. However, the rally that we have seen in stocks is normal coming out of a bear market. By looking at the chart below, the 1 year average return after a 20% drop in the market is over 41%.  3 years out from a 20% drop on average leads to an average annual return of 16%.   

What about bonds?

2020 has been one of the top performing years for bond investors.  This chart shows the return of bonds so far this year and as you can see they are up 5%. This is the importance of keeping a diversified portfolio. The shifts I will be making for my clients over the next couple of months will be into longer duration treasury bonds and short duration investment grade credit.

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Depending on where you have your money invested you may have noticed that your account balance is close to or maybe even higher than it was before the Coronavirus pandemic closed down he economy in the United States.  Here is a quick look at how a few major benchmarks of the stock market have been performing as of 05/27/2020.  

As you can see the S&P 500 is down only single digits on the year, while the Nasdaq 100 is up 8.5% on the year. The Nasdaq 100 tracks the stock price of technology companies and many of these companies have been able to weather the storm of the pandemic and some have even thrived due to the lockdown.  Even with a 29% drop during the bear market in March, the Nasdaq 100 is up over 30% in the past 12 months.  The S&P 500 during this same 12 month time period is up over 9.66% and small cap stocks are down 3.6% during this time.  

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What has caused this?

As Schwab’s Investment Strategists have put it, the country is “riding the liquidity wave.” The economy seems to have reacted nicely to the federal reserve providing swift and massive action to businesses. The $2.5 Trillion stimulus money that has flooded the market has allowed companies to maintain their businesses throughout the shutdown.

Moving forward we will start to see which companies have been fundamentally sound. The reopening of the economy is happening in states all around the country. The likelihood of another stimulus bill getting passed seems to be a long shot at this point.   Once this liquidity from the PPP loans and stimulus checks runs out we may see the residual affects of the shutdown start to show itself much later on than we had expected.  

Like any good sports team, you need both a good defense and a good offense, and the same is true for investing.  As an investor you will need to decide which risk you are willing to live with: the fear of losing money or the fear of missing out on an opportunity.  This is a tradeoff that we all face when investing our money.  We witnessed the fastest drop to a bear market in history early this year, however, since the low on March 23rd the market has rebounded over 30% since then, even with a flood of negative headlines.  Many now believe that we will not revisit these lows in the stock market because the bad news that we will see going forward has already been priced in. However, on the other side of the coin maybe the stock market recovered too quickly and is not pricing in the event that this reemerges later on in the year.  Since this is uncertain, what can investors do that do not want to stomach another drop in the market? The answer is to first determine what amount of money they need to keep safe, then develop a defensive investment strategy for that money.

A defensive investment strategy is one that aims to minimize loss of principal during a market downtown.  A defensive side of your portfolio is one that is to be invested conservatively to protect a portion of your portfolio.  This is done through proper asset allocation and a strategy known as rebalancing to maintain those asset allocation percentages.  Here are some of the investments to utilize in building a defensive investment strategy, guidelines to how much you should allocate and the best way to execute on these investment decisions.

What are Defensive Investments

High Quality Short Maturity Bonds

The first defensive strategy to look at is short maturity high quality bonds and most specifically United States Treasury bills or notes.  These are one of the most common investment vehicles in defensive portfolios and have historically been known to be very safe a conservative providing investors with a relatively small amount of interest while trying to minimize risk.  Historically you can buy these from large banks, however today this are made easily accessible in Exchange Traded Funds at brokerage firms.

Defensive Stocks

These stocks tend to be stable investments with a track record of paying an above average dividend.  These are companies that have a constant demand for their products and tend to remain stable during different market cycles.  They are good for reducing the overall risk of a stock portfolio and still have the potential to deliver a slight higher total return.

Cash Equivalents

The most conservative investment option is cash equivalents. These investments are also referred to as money markets or stable value funds.  This is the lowest amount of risk for the lowest amount of expected return.  This money should be used for short term liquidity needs.

How much should you allocate to a defensive strategy

Obviously this is a tough question to answer because everyone has different goals, time horizons and willingness to take risks.  However, having a good financial plan can be a great starting point for making these decisions.  For individuals that are approaching retirement, a good rule of thumb to use for the amount that should be conservatively invested is 3 years worth of living expenses.  The thought behind that is that is typically takes a little over 3 years for stocks to return to their previous highs after a bear market.  This will ensure someone in retirement or approaching retirement has the money they need and will not be selling their stock positions at a time that is not most advantageous.  Another rule of thumb for younger investors may be the rule of 120. To apply this rule you simply subtract 120 minus your current age. The amount you are left with is the amount you can afford to invest in stocks or something more aggressive. The remainder can be used for your defensive bucket of investments.

Implementing a defensive strategy

Throughout the years the barrier for entry to implementing a defensive investment strategy has dropped significantly.  This strategy became easier with the emergence of index funds. Index funds track a certain index or sector of investments. The advantage of index funds is they provide broad diversification at a very low cost.  Similar to index funds ETF’s have become more and more prevalent in the investment world. ETF’s are passive investments that also track an index or a sector.  These two products have made it significantly easier to invest in the bond market. Instead of having to invest in individual bonds or individual stocks an investor can own the index and have broad diversification.  The final barrier to entry that was removed was dropping commissions on stocks and ETF trades to 0$.  An investor can know open an account for free and trade for free to get their money invested.  Determine your defensive bucket is very difficult to navigate for a novice investor. The simple solution would be to put the money into cash, however, this may not be the best use of your money.

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Buy low sell high is the strategy that every investor strives to accomplish.  Those that may have kept cash on the sidelines during the recent market highs may have just been presented with an excellent opportunity to buy quality companies at a discount.  The Dow is coming off the worst week since 2008 and here is a chart of how the Dow has performed this year as of market close on Friday 3/20.  

This may cause a lot of investors to fear, especially those that are nearing retirement. However, it is important to remember that we have faced bear markets in the past and 100% of the time we have recovered from them.  What really matters is time in the market as opposed to timing the market.  Over time, what has mattered is that you buy, not when you buy.  

No one can time the bottom in a bear market. However, that should not prevent you from investing. As you can see from the chart above the stock market has seen more bull markets than we have bear markets.   The best way to invest during these times is to stick to a disciplined plan.  A recurring buying strategy is the best way to control your emotions during these times. An example of this would be “invest 20% every Friday for the next 5 months.” This will take the emotion out of your investment decisions and allow you to work your money into the market.

For farther reading check out Michael Batnick’s post here.

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