Broken Window

Hurricane Ida caught the news, as it left millions of people without power in New Orleans only 16 years after Hurricane Katrina. Natural disasters are great tragedies, but ultimately, we will focus our discussion on the effect on the economy.

 

Let’s start with the broken window fallacy, penned by French Economist Frederick Bastiat. This fallacy disproves the myth that the destruction of property is beneficial to the economy. So in a situation where there’s destruction, we may not see a change in GDP, but we do have a society with less wealth. So, therefore, we don’t measure the economic activity that is unseen.

 

Natural Disasters

Most Numerous Natural Disasters Wall Street Journal GWS
Source: Wall Street Journal

When we look at natural disasters, hurricanes are one of the most consistent and significant ticket items. However, we do have a property and casually for these disasters because they are tragedies. But let’s take this and compare it to the same scenario from Frederick Bastiat, the seen versus unseen.

 

When you look at the New Orleans economy, it’s going to look like it’s been stimulated by GDP because there is a transfer of money that has been sent to replace the infrastructure that Hurricane Ida has destroyed. So, this is the “seen” part. But what we won’t see is the money that the property and casualty companies would have used and saved for other investments to fund future catastrophes, where they would have to payout. So, therefore, we are not losing our spending as an economy but all the innovation that would have come from the property’s investments.

 

Storm Costs

Storm Costs Wall Street Journal GWS
Source: Wall Street Journal

Another thing that happens a lot whenever hurricanes come about is the severity of storms and that storms are getting worse. It is likely not the severity of the storms driving these costs up over time; we are developing areas in our communities.

 

So if, if we had a storm come through and it’s across the beach, and there’s no development whatsoever, we’re not going to account for all the different changes that happened in the environment because there was no economic component. So, therefore, as our economy continues to grow, the additional infrastructure increases.

 

Florida

So let’s analyze Florida because hurricanes are typically the most significant event that we see in Florida.

Florida Population 1845 to 2004 GWS
Source: Thirty Thousand Pages

We can look at the population growth for Florida and see 1960 Florida is not the same as present-day Florida. When we talk about the electoral college, Florida has a significant influence. It’s one of the most populated states in the country, but not the case in the 1960s. We can see that the population since the 1960s has increased. So you may be thinking the population increases everywhere, so why Florida?

 
Number of House Representatives from Florida 1845 to 2004 GWS
Source: Thirty Thousand Pages

Well, we can see how the population influences Florida as the house of representatives increases over time. In 1944 they had six representatives; by ’64, they had 12, and in 2004 they had 25. This number is likely to go up with the number of people continuing to move to that state. But all the increase in population means that beaches that were empty before now have all kinds of infrastructure surrounding them. So whenever a hurricane comes through, there are more places to hit and what’s driving the increased costs.

 

Infrastructure Spending

Bipartisan Infrastructure Framework GWS White House
Source: The White House

Infrastructure spending has been moving slowly, and there has been a lot of going back and forth with politics. Janet Yellen wanted to get the $3.25 trillion passed before the infrastructure bill, but the Senate has now approved an additional $550 billion in spending. The extra $550 billion is set to be voted on September 27th.

 

Although natural disasters come and go, our economy can take the hit for longer. Keep up to date with the effects of Hurricane Ida on our economy and more every Wednesday at 3:30 p.m. CT. And to learn more about this week’s Weekly Market Insights, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

 

The opinions in this material do not necessarily reflect the views of LPL Financial.

Astrology for Adults

When analyzing stocks, there’s more to evaluate than simply revenue, valuation, and industry trends (i.e., fundamentals). Of course, these factors are essential, but they don’t always show up in the market price. That’s why we also do what’s called technical analysis. You’ve probably heard me refer to technical analysis as reading tea leaves because the process involves a level of subjective prediction based on historical data.

 

Chris Arends, our Portfolio Analyst, has even more confidence in technicals. He considers technicals “astrology for adults”! We joke, but we do spend a lot of time analyzing technicals. We know that factor investing does work, and a lot of times, reading the charts and technicals will get us a particular element in the market and a signal through the noise.

 

Let’s jump in and look at the different asset classes we typically review during technical analysis.

 

Performance of Asset Classes on a Technical Analysis

 

Looking back to August 20-24th, we see crude oil rebounding quickly. But then, if we look at a seven-day window, we can see that the Russell 2000 is positive, and the NASDAQ composites are up — as well as gold and the core bond. Therefore, there is a quality bias to these types of asset classes.

 

S&P 500 Large Cap Index

S&P 500 Large Cap Index Chart
StockCharts

Looking at the images above, you’ll notice how the S&P 500 is moving on the left chart. A point and figure chart are on the right, which is an excellent way to see where support levels are. So, for example, you can see the July bottom was at 42/30, and in June, it was at 41/60. One thing to note is that the S&P 500 is one of the few indexes having a breakout while also making new all-time highs.

 

Russell 2000

Now, let’s review the Russell 2000 small-cap. You’ll notice it doesn’t have a quality factor like other indexes. We can see that it had been trending up for quite some time and had significant outperformance, but it’s been a flat line since April.

Russell 2000
Daily Equity & Market Analysis

Another way to think about this is by dividing the Russell 2000 by the NASDAQ 100. Whenever the Russell 2000 (purple line) moves up, it outperforms the NASDAQ 100. Then, when it’s moving down, the NASDAQ 100 is outperforming the Russell 2000. We can also compare it to the interest rate on the 10-year treasury (on the axis). As you can see, we start below 1%, move up to 1.75%, and then back to 1.2%. The trend that we notice here is when interest rates move up, the Russell 2000 outperforms. Then, as interest rates decrease, the NASDAQ comes back in.

 

MSCI EAFA compared to the S&P 500 Sector Weighting​

Next, when we look at international indexes, we analyze demographics and other characteristics besides the value growth aspect. But you want to be cautious about entering any global indexes because of low price to earnings. So, let’s look at the exposure breakdown of the broad index of international developed companies compared to the S&P 500 based on the sector below.

MSCI EAFA compared to the S&P 500 Sector Weighting
MSCI and S&P 500

First, cash or derivatives are being minimal on the amount of money they hold. Then, we can see that the EAFA holds 4.68%, while the U.S. holds 11.26% in large-cap. If we go to the biggest holding in the international index, we can see its financials at 16.74%, while the U.S. is 11.12%. Therefore, there is a significant overweight relative to the U.S. markets towards finance. On the other side, if we look at information technology, the S&P 500 has almost 30% waiting while the EAFA has less than 10%.

 

One Belt, One Road

In the last couple of months, it has become a tough market in China, which makes up about 30% of the emerging market benchmarks and indexes. Some excellent companies look innovative, but as soon as they start looking too good, the communist party overpowers them. This isn’t a political issue but rather geopolitical. The real question is, is China investible?

One Belt, One Road Silk Road Economic Belt and Maritime Silk Road Initiative
One Belt Road Initiative

Also, the problems occurring in Afghanistan have a significant impact on the market. China has been working on the ability to create this “one belt, one road.” Historically, the red line represented the Silk Road until the west became a maritime superpower. Then, England went through and built the Suez Canal, where they could control trade. Now, China is trying to make inroads into reopening that Silk Road. But, then, with the power vacuum in Afghanistan, we’re starting to see them approach the Taliban as the U.S. leaves.

 

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To learn more about this week’s Weekly Market Insights, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

 

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

 

The opinions in this material do not necessarily reflect the views of LPL Financial.

 

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested directly. All performance referenced is historical and is no guarantee of future results.

 

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

Active, Passive, or Sales Pitch?

Active, Passive, or Sales Pitch? The GWS Stance on Active vs. Passive

 

The efficacy of active vs. passive investing is one of the oldest debates in the books. But it’s not that simple — and, often, these terms are just used as part of a sales pitch. At Gatewood Wealth Solutions, we are neither active nor passive; we are agnostic. Instead, we use strategies we discern that are better for our clients based on their specific situations and goals.

 

Why isn’t this as simple as it sounds? Think about it: we’ve all heard people say, “I’m a passive investor.” But what do they mean by that?

No One Is Truly “Passive” When It Comes to Investing

If you mean, you’re not doing much, that makes a lot of sense. Passive investing is a set-it-and-forget-it type of strategy. But what is typically represented by having a “passive strategy” is that you have no opinion on different markets — that everything will average out over time, and the time and cost of underwriting that is not going to bear any fruit. Like any strategy that gets market exposure, it will work at the end of the day! And there is nothing wrong with it. You, at a minimum, will get the market minus fees; you may just not get the best performance.

 

Even then, everyone has a different “passive strategy.” For example, let’s say you decide just to buy an index — the S&P 500 — as your “passive strategy.” Already, you’re saying, “I believe these U.S. large-cap companies are my best investment option, so why would I buy anything else?” You have an opinion and are taking an active tilt.

 

Plus, with a strictly S&P 500 portfolio, about 25% of your holdings are going to be in just a handful of stocks. So your portfolio is going to be dominated by Apple, Microsoft, Google, and other big names that may or may not form the concentration that you want. And, in a rising rate environment, those technology stocks could drastically underperform the rest of the stocks in the S&P.

 

This strategy also begs the question: is index-buying genuinely passive? Suppose you’re employing a truly passive strategy. In that case, you should have a market-weighted approach — meaning you’re taking into account the percentage of Apple, for example, versus all the other investments out there. Under that methodology, you would have a minimal position in Apple, emerging markets, international markets, available commodities, precious metals, private equity, venture capital, and bonds. So, no one truly is a passive investor.

 

The Paradox of Passive

If markets are reasonably efficient, it’s not necessarily wrong to passively invest — meaning you’re not going to pay for the underwriting and due diligence. But then you have the paradox of passive investing: If the market is efficient, meaning stocks are rationally priced and trading at a fair price given all known information, where are we getting that information? Active investors. They’re the ones behind the scenes trying to move the stocks to do the rational thing. If everyone were to invest passively, active investors would have a bonanza to do due diligence.

 

Given this paradox, we see cycles of active vs. passive being popular strategies. At first, there may be a surplus of active managers since there’s so much excess return through underwriting. Once stocks get to more efficient prices, though, there will be fewer excess returns, meaning stocks will start to underperform the benchmark. At that point, more capital will flow back to passive strategies, and there will be more movement in stock prices that are no longer efficient.

 

Knowing this cyclical nature of active vs. passive trends, we build these cycles into our portfolios. We use active managers at some times and passive at others if we’re in a period where there’s a better opportunity to maintain the market.

 

Again, because of how we view the active vs. passive debate, we’re agnostic. We’ll use ETFs if they have a basket of stocks that we want at a meager cost on the internal management fee vs. a mutual fund. We approach our fund decisions with the mindset of, “What basket of stocks — whether it’s an ETF or active manager — are working well? Which help us get to where we want to go?”

 

Digging into the Data

Whatever is doing well is doing well for a reason — and is likely to keep doing well until there is some type of narrative change. That’s why we monitor performance so closely.

We believe an agnostic strategy is still an excellent approach to management, despite what looks to be a very efficient market. The benchmark typically ends up in the second quartile, so some funds are doing slightly above average.

 

Then, if we look at the three, five, and ten-year, there’s a lot of consistency in what was doing well in 2017 and what continued to do well going forward. There’s a sleight of hand used in our industry about a passive approach and the assumption that you can’t outperform the market in the long term. We see 25% of the companies are consistently in that top quartile, and we haven’t come across the page where the benchmark is in that top quartile.

 

Again, whatever is performing well will maintain momentum until there is a change in narrative. The main point is the sectors that do well will continue to do well — and if you over-allocated those sectors, you would have been in the top quartile of those funds.

Everyone is doing a form of active management. We all have some type of opinion; no one is buying a proper passive portfolio. We are happy to provide you with more performance data to further demonstrate our portfolios’ efficacy; just contact your advisor.

 

Of course, there is no right or wrong when choosing a path to invest in, but at GWS, we try to give you our data-driven view of economic theory. Our goal is to dig deeply into market behavior to inform you better to make actionable decisions to achieve your goals.

 

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To learn more about active and passive investing, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

 
 

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

 

The opinions in this material do not necessarily reflect the views of LPL Financial.

Risky Business

The Delta variant-induced rise in Covid-19 cases is still capturing headlines, although we haven’t seen a significant increase in the number of deaths occurring. A few states have mandated masks with a potential lockdown, but this is mainly political. Nevertheless, if hesitation around the prevalence of the Delta variant persists, we would expect a significant impact on the market.

 

As we keep an eye on Covid-related market behavior, it’s also essential to evaluate market changes in the context of seasonality. Let’s dive in.

 

Significant Data Growth by Season

Nearly 300 out of the S&P 500 companies reported data on earnings this month. Eight-eight percent of those companies have beaten their revenue expectations, and 87% have exceeded their earnings expectations. So we have revenue growth of 23.1% and earnings per share at 85.2%, starting to explain why the market has been up.

Monthly S&P 500 Returns April 1987 - June 2021
Source: Nasdaq Dorsey Wright

Let’s examine each season more closely. We can immediately see the differences in appreciation of value, specifically in July. However, August, September, and October are historically rough months. For example, August’s maximum/minimum return is down 14% and up 7%. In contrast, October has the lowest minimum historical return of 21.76%. Therefore, we are getting into the months where we need to be more cautious.

Time Since 5% or Greater S&P 500 Drawdown (Trading Days)
Source: Goldman Sachs

The Goldman Sachs chart above shows how many days have gone by since the last 5% pullback in the S&P 500. Currently,184 trading days have passed since the previous 5% S&P 500 drawdown. This marks the 15th most prolonged period without a meaningful pullback and is significantly above the historical average of 97 days. However, historically speaking, we are due for a correction.

 

Variables Impacting the Market

Gatewood Wealth Solution Market Spider Graph
Source: Gatewood Wealth Solutions

You’ve heard us mention that our GWS investment committee is becoming a little more cautionary in the market, especially heading into August, September, and October. The spider graphs above capture the reason why. In addition, these graphs reflect several vital points within the market that demonstrate the probability of having a market pullback, correction, or sell-off.

 

Money supply has been declining, and the yield curve is still positive, but it’s significantly lower than last month due to declining interest rates. Regarding the bullish percent index, few companies make highs relative to lows because consumer spending has been down. Lastly, housing and manufacturing are still positive, while transportation has remained constant.

 

Money Supply

Money Supply 13 Week ROC vs SP 500 2021

In 2020, we saw a massive spike in money supply (green line). As a result, the annualized growth rate was about 60%. However, today’s money supply (red line) and the S&P 500 (dotted line), which historically are tracked together, are beginning to trend down, slowing the growth rate.

Yield Curve - 2 Year Bonds (EOD) INDX

Then, when we look at the yield curve, we are beginning to see a decrease in growth. When a yield curve gets close to negative or almost zero, it is a significant indicator that the economy doesn’t have enough cash relative to all the projects they put in place when the money supply was growing before.

 

If we don’t have that correction in money supply, it could be detrimental to the market. We see the effects of high inflation in energy and food items especially. Energy is up to 10% annualized, where food and all other things are around 5%.

Percentage change in Consumer Price Index from February 2020, selected categories
Source: U.S. Bureau of Labor Statistics

To learn more about how seasons affect market behavior, be sure to keep an eye out for our recap video on our YouTube channel and SUBSCRIBE!

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

 

The opinions in this material do not necessarily reflect the views of LPL Financial.

 

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

COVID 2.0

Here in St. Louis, politicians have been flip-flopping on the mask mandate in the county and city, now that the CDC has released new Covid-19 guidelines. Most notably, the organization recommends even vaccinated individuals wear masks indoors in public when in areas of high transmission due to the prevalence of the new delta variant.

 

Today, we will uncover what signals impact the market. So forget about all this political talk that you hear in the news and learn more about the data behind the action below.

 

Increase in COVID Cases

We’re now seeing a rise in COVID cases across the states. Louisiana has the highest daily average case rate in the United States, with the U.S. only having a 49% vaccination rate.

Gatewood Wealth Solutions COVID-19 Daily Average State by State

Then, if you look at the United States as a whole, you can see the behavior of the hotspots. For example, COVID cases show up in the Ozarks, move down to Springfield, cross into Arkansas and Louisiana, and Florida.

Gatewood Wealth Solutions COVID Hot Spots Average Daily Cases per 100,000 people in the past week

When you look closer at the Missouri hotspots, you’ll notice a slight uptick in deaths with a decent increase in hospitalizations. However, taking a closer look at the hotspots versus risk levels, you can infer the city of St. Louis is not one of the risky places. St. Louis is only number 77 out of 117 counties. Therefore, the overarching question is: is there a relationship between the number of people vaccinated versus the amount of Covid-19 cases?

Gatewood Wealth Solutions COVID Hot Spots Missouri vs. Risk Levels
 

Vaccinations

With most vaccines, the higher the percentage of vaccinated individuals, the less likely an outbreak will occur. But when we look at the numbers of Covid-19 vaccinations in each country, specifically Gibraltar, a region of the United Kingdom, you can see surging cases.

Gatewood Wealth Solutions Share of People Vaccinated against COVID-19, Julie 26, 2021

Gibraltar has a 116% vaccination rate, which may not be entirely accurate because data is not always clean. Canada is second to Gibraltar with a small number of cases. The United Kingdom is ranked third with a high rate of increased cases. Also, Sweden’s vaccination rate is higher than the U.S. but lower than the United Kingdom. Sweden has not seen a significant uptick and has zero deaths some days. ​

 

Professor Neil Ferguson, the controversial epidemiologist who predicted as many as 200,000 COVID cases a day in the U.K. if restrictions were lifted, is now facing scrutiny after infections continued to drop for the 6th day in a row. Again, this proves models don’t always reflect reality.

 

Per Capita Deaths

Gatewood Wealth Solutions Cumulative confirmed COVID19 deaths per million people, July 26, 2021

Every country got hit by the coronavirus differently. Still, because we have better therapeutics, even with increasing cases, it may not have the same impact on the market as it did in the past.

 

For a full deep dive into the second wave of COVID-19 and current market behavior, watch our recap video on our YouTube channel and SUBSCRIBE!

 

For detailed performance metrics, please don’t hesitate to contact your lead advisor.

 

And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

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Disclosures:

 

Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

 

The opinions in this material do not necessarily reflect the views of LPL Financial.

What Is a Good Price-to-Earnings Ratio?

This week, the market spooked a bit following the potential rise of the Covid-19 Delta variant. In this post, we’ll quickly walk through short-term bond market behavior before diving more deeply into our main topic: understanding how to read a price-to-earnings ratio.

Starting with the technical side of things, you’ll notice the bond market showed a safety trade last week — likely from the Delta variant and expectations of a possible lockdown again. As a result, Treasury yields on the 10-year have gotten down to 1.13, which is very low.

Graphic of near-term relative strength.

This graph also reflects the scared, cyclical side of the equity market. You can see week after week, mid and small-cap values continue to move lower, while large-cap growth remains at the top.

 

In summary: after an initial drop in the market due to fear, we’re starting to see it rebound.

 

Price-to-Earnings Ratio

Now, on to our main topic for today: Understanding the price-to-earnings ratio. We’ll discuss what it is, why it’s valuable, and how to identify a fair price-to-earnings — or P/E — ratio. The P/E ratio is calculated by dividing the market value price per share by the company’s earnings per share.

Price-to-earnings ratio calculations.

Source: Investopedia

 

Since you’re dividing the price by earnings, the P/E ratio tells you exactly how many dollars you’re spending for each dollar of earning on the stock.

 

The main benefit of the price-to-earnings ratio is that it allows you to compare the prices of different stocks quickly and easily.

 

Now, let’s take this one step further. Research shows that stocks are worth the present value of the cash you could take out over the lifetime of the stock. So, just looking at the P/E ratio may not be enough. You also need to understand the stock’s cash flow behavior since, over the long-term, that’s what will drive stock performance. Finally, you must figure out a way to discount for the future value of those earnings.

 

How does that work? First, think of the valuation of cash flow for the S&P 500. When analysts calculate that valuation, they use both dividends and cash buybacks. So, you must project what both of those will be for your stocks to get your payout ratio. Then, you’ll divide that by your equity risk premium and a growth rate. How to Identify a Fair P/E Ratio

Let’s look at historical P/Es. In this chart, we see P/Es around the range of 16.5. Right now, we’re around 21.5. For reference, the average P/E for the S&P 500 has historically ranged from 13 to 15. To determine if a P/E ratio is fair, you should compare it to other stocks in the same industry, as well as relevant benchmarks.

Graph of S&P 500 valuation measures through 2021.

We hear all the time from clients, “I don’t want to invest when P/Es are above average.” But if you’re afraid of high P/Es, you would only have had two chances to invest in the last five years: when the Fed tightened in 2018 and during Covid when P/E had fallen entirely, and the world was ending. If you didn’t invest during those times, you would have missed out on 22% returns in 2017, 30% in 2019, and 18% in the last two years.

 

Not only is it a bad strategy to assume, “High P/Es man we have to sell,” it also overlooks that high P/E can be an indicator that the market is thinking there’s going to be substantial growth in earnings. So, the reason you’re paying a higher P/E could be that analysts simply aren’t as bullish as the market.

What This Means for 2021

If we’re trying to set a price target for the end of the year, we need to look at where earnings will be. Then, to use a forward multiple, we need to see where our earnings will be at the end of next year. So, we use a consensus estimate (meaning an average of all analysts’ projections). The end of the year is about $191 on the S&P 500 in earnings. Looking out to the end of 2022, we see about a 12% growth rate to get $214 in earnings. So, we get a price objective target by the end of the year of 4,600.

 

This was a base scenario; let’s consider a bull and bear. In a bull scenario, we might say earnings grow at 15%, and the market does want to pay a higher multiple. Now, we’re starting to see a price target of $5,000, a 15% upside of where we are. In a bear market, we might see earnings coming down to 8% and pay a lower multiple with a downside of 10%.

 

For a full deep dive into P/E and current market behavior, be sure to watch our recap video below and on our YouTube channel. Of course, your GWS team is always available for questions, too!

GWS What Is a Good Price to Earnings Ratio? YouTube Video
 

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

Taper Tantrum

With significant Consumer Price Index (CPI) increases over the last year, many are wondering: “Are index increases transitory?”

 

Over the last 12 months, all items on the CPI increased 5.4% before seasonal adjustment; this was the most significant 12-month increase since the period ending August 2008.​

Gatewood Wealth Solutions 12-month percentage change, CPI, selected categories, June 2021

In reality, everything is transitory because, at some point, it will end. So the question is the duration of time. I think it’s fair to say this increase has lasted longer than what the Fed initially expected, but it doesn’t seem that they’re concerned.

 

For example, if we look at sales of used cars, you can see a 10.5% growth in June after a 7.3% and 10% growth before. And because the semi-conductor shortage curtailed the number of new cars being created, we see elevated prices in vehicles.

 

We haven’t seen this type of inflation for quite some time, but if you look at PPG, a supplier of paints, they would say inflation has not been transitory. PPG Industries Inc. repeatedly raises prices of the paint and coatings it sells to customers across industries as inflation in raw material and logistics costs pressures the $40 billion business. Looking back over the past year, we have also seen several home price increases.

 

Home Price Increases

The annual percentage of home prices in 2020 had a 12-14.5% price change on homes. But then, the monetary policy showed the spike coincided perfectly with the Feds stepping into the market and buying $40 billion per month of mortgage-backed securities. And to top it off, the Feds are still doing it despite a 14% increase. Therefore, the housing market is robust with the question of, “Are we in a housing bubble?”

Gatewood Wealth Solutions Annual Percentage Change in Home Prices and MBS Holdings Fed vs. Bank

We hear a lot of noise about house prices, but the biggest driver of home prices ultimately is per capita income. The more money you have, the more house you can afford — and the more you’re going to bid against other buyers. So, the significant long-term driver is the income you produce and the payments you can make to own a home. Just remember, if interest rates are low, the house’s value can appreciate.

 

Small Businesses Planning to Hire

Are small businesses planning to hire? Can they hire enough workers? The NFIB is a small business association helping understand what is happening from an economic standpoint. William Dunkelberg, NFIB Chief Economist, stated, “in June, we saw a record-high percentage of owners raising compensation to help attract needed employees, and job creation plans also remain at record highs. Owners are doing everything they can to get back to full, productive staff.”

Gatewood Wealth Solutions NFIB Jobs

If you look at the data above, we can see that more than 50% of small businesses have at least one unfilled opening at the moment, and 30% of the small companies are trying to hire. However, what stands out is we have more job openings and employees that quit relatively to unemployment. So for those who want a job, there are plenty out there.

 

Taper Tantrum

On May 22nd, 2013, Federal Reserve Chair Ben Bernanke announced that the Fed would reduce the volume of its bond purchases.

Gatewood Wealth Solutions U.S. Treasury Yields

We saw interest rates rapidly increase from his announcement, causing the media to coin the term “Taper Tantrum.” Unfortunately, because we had never seen this behavior before, there was no policy that we could look back at to see how the statistics would play out.

 

However, when the Fed began implementing the bond purchase strategy a few months later, you started to see yields decrease again. So the Feds are certainly keeping interest rates lower than they would have naturally, but we don’t believe their suggestions are that far off the natural pace.

Gatewood Wealth Solutions Federal Reserve Balance Sheet 2019

This first taper represented a slowing of asset purchases, and it was what we would consider a proper taper. However, the second taper tantrum we’ll look at was much different. Under Federal Reserve Chair Janet Yellen, the Fed announced caps on the maximum number of Treasuries and Agency MBS allowed to roll off each month.

 

​As a result, the Fed’s balance sheet shrunk, but the Fed continued to buy large amounts of treasuries. ​By signaling a gradual plan, the rates did increase but over a more extended period. Eventually, the rates decreased as the market better understood the implications.

 

Consumer Price Index (CPI)

Gatewood Wealth Solutions CPI 2017-2021

The graph you see above — called the Consumer Price Index for All Urban Consumers: All Items (CPIAUCSL) — measures the average monthly change in the price for goods and services paid by urban consumers between any two periods. We had a considerable CPI number of 5.4%, causing yields to come down slightly, eventually rising. But then, July 13th was a growth day where we should have seen a value rotation. Also, the dollar increased relative to other currencies.

 

Overall, these statistics have been unusual. There has to be more to all of this than interest rates increasing. As the story unfolds, tune in to GWS’ YouTube Live every Wednesday at 3:30 p.m. CT for our take on what’s happening in the market.

 

——

 

For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

 

All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

Q2 2021: Follow the Data, Not the News

Executive Summary

You already know how important it is to us at Gatewood Wealth Solutions to serve as a trusted source of financial information on all things market- and economy-related. We want to signal through the noise to help you understand what’s worth paying attention to and what’s just media hype. But that’s no easy task when you’re finding yourself constantly bombarded with fear-inducing headlines and social media threads.

 

Recently, we heard one economist share that his mantra is, “Follow the data, not the news.” Of course, that resonated with us immediately, as it’s precisely what we strive to bring to our GWS clients and Weekly Market Insights listeners. The reality is that if you follow the news, it’s easy to become very fearful. Think about it — the news is in the business of selling advertisements. And one of the best ways to get you to sit through a commercial or an ad is to scare you just enough to listen. But, on the other hand, if you look at data, you gain a better sense of what’s happening in the market and make informed decisions based on those insights.

 

Speaking of digging into the data to find actionable insights, let’s dive into our key themes from Q2 of this year: inflation expectations, value/growth rotation, housing market boom, and supply chain blockages. We’ll start by looking at the market’s behavior as we wrap up this quarter.

 

Wrapping Up Q2 on a High

As of this writing, today is the last day of the month, and it looks like we’re going to end in a gain position with the market. This will be the fifth month this year so far. But are we at the top?

 

No one rings a bell when market performance peaks, so there’s no way to be sure. But we are following some fairly pervasive patterns. For example, take a look at the graph below, which shows the seasonality of the market.

Percentage of Months in Which $SPX Closed Higher than it Opened from 2012 to 2021

As you can see, the chart above looks back over the last ten years at each month. We see how often the S&P is higher from when it began. A few observations:

  • January has been up 50% of the time over the last ten years.

  • If we frame April, May, and June as a quarter, that’s the best quarter based on seasonality.

  • July is up significantly; 89% of the time, the S&P has been positive for July.

  • Going back further, September and October are the months with the highest likelihood of a correction.

You might ask, “If we’re entering into July, will that impact the decisions we make since it tends to be a higher month — and then there’s a higher chance the market will be down?”

 

The answer is no because most of the time, in this scenario, we still have positive months. Fifty-six percent of the time over the last ten years, the S&P continued to move up and into positive territory during this period. This is known as technical analysis. We think there are economic reasons that corrections happen in October, but this doesn’t tell us if we’re due for one or not.

 

Next, let’s look at the volatility of the market. What’s the likelihood of a correction coming up?

$VIX Volatility Index - New Methodology INDX June 2021

Let’s start by considering the Volatility Index (VIX)— or what many people call the fear index. This measures options: calls and puts. What are calls and puts? A call option gives someone the right to buy a stock, and a put option gives them the right to sell it. A call is essentially a down payment for a future purchase.

 

As an example, let’s say Aaron owns AT&T when it is trading at $50. If he sells it to John at $55, and John pays $2 for the right to repurchase it at $55, John might repurchase it when the stock moves up to $60. The longer the option lasts, the more valuable it is.

 

Since April of 2020, the VIX has been trending down. However, the options in the market are trending in a way that doesn’t suggest a high probability of a correction at the moment. (Watch our Weekly Market Insights recap video for a full explanation of how we measure volatility.)

 

Theme 1: The Value/Growth Rotation

This quarter’s value/growth rotation has been somewhat of a teeter-totter: volatile on the edges but a calm constant in the middle.

 

For example, consider the graphs below showing how much the market was plus or minus 1% on a given date. Thus, 2021 looks somewhat average in terms of volatility, which might seem strange. But, there’s more to the story.

NASDAQ DORSEY WRIGHT - Number of 1H +/- 1% Days and Number of 1H +/- 2% Days, Data from S&P 500 Index, 4/30/1987 through 6/25/2021

Now, let’s look at the edge of the teeter-totter: the ongoing value/growth rotation roller coaster. In the graphs below, we separate growth and value and look at how much they were plus or minus 1% on a given date. Again, you can see the charts look far more volatile.

ASDAQ DORSEY WRIGHT - Number of 1H +/- 1% Days for RPV and Number of 1H +/- 2% Days for RPV, Data from Invest S&P 500 Value Portfolio 7/3/1995 through 6/25/2021

For most of the year, especially the first part of the quarter, we’ve seen a value rotation in the market. As a result, we’ve made relevant changes to our portfolios, balancing those changes, of course, with tax impacts.

 

Theme 2: Inflation

Talk earlier this year of an additional $6 trillion in stimulus money sparked many discussions on inflation expectations. Now that those stimulus numbers have been reduced – and we see deflationary forces from technology and other areas – we don’t view inflation risk as high as it previously was. So we may see a bit of a reprieve on inflation going forward, which may also be the reason for the growth rotation mentioned above.

 

The Biden administration has the difficult task of making Manchin and Sinema happy while also trying to appease more centrist republicans like Romney when going after the filibuster. Currently, we believe the filibuster is too far away from markets and into politics for us to comment on.

 

Theme 3: Housing Market Boom

As the housing market continues to add fuel to its fire, many people have flashbacks in their minds to 2008 and wonder if another housing bubble is forming. The short answer is yes, it is developing — but it won’t pop now. There are four key reasons why:

 
  1. First, inventory is the lowest it’s been in 20 years.

  2. The stimulus bills increased liquidity. As a result, default rates are low, and the number of customers at risk of becoming delinquent is down 90%.

  3. Bank lending requirements have changed since the aftermath of the 2008 financial bubble. The practices are much stricter, so it’s less likely to get out of control.

  4. Millennials are aging and advancing their careers — so the demand for housing won’t abate any time soon.

Theme 4: Supply Chain Bottlenecks

Avid listeners of our Weekly Market Insights will recognize supply chain bottlenecks as a common topic over the last quarter. However, we are finally starting to see supply chains open up again, although there is still a significant shortage of truck drivers.

 

We had expected to see a declining dollar to reduce imports and increase exports — but that hasn’t happened yet. This is likely because consumers have shifted their expenditures to imports since the service economy was shut down.

 

For example, if they couldn’t go to dinner, a couple might have spent that $80 on clothing or another consumer good instead (products that are more likely to be manufactured in other countries; thus, imports). This increase the demand for shipping coming into American ports, but more miniature goods were leaving. This was causing issues in distribution and logistics. Especially for shipping containers, they arrived in the US but did not leave, meaning a global shortage in containers.

 

Now that the service sector is recovering, it will be interesting to keep an eye on the effect on imports, exports, and the dollar’s value.

 

Looking Forward

Looking outward at the rest of the year, we believe we are starting to see growth reassert itself.

 

We were concerned that if we didn’t break through this dome, we would start to dip. I’m happy to say the market wanted to go through that tactical dome, and there was more demand for stock positions (people seeking to buy) than the supply of stocks (people selling at current prices). Hence, stocks moved up at price because there is always an equal number of buyers as sellers.

$SPX S&P 500 Large Cap Index INDX - Price Points for Dollar Cost Averaging

What’s happening in the market has consolidated and is taking a breather. The longer it’s taking the break and trying to decide if it’s going to upside or downside, the greater the movement will be when it happens. So, we’re reading tea leaves here, but based on technical analysis, this tends to be a good indicator of how much price upside and downside risk we have.

 

Conclusion

When we start to think about the risk on the upside vs. downside, it’s a pretty favorable market at this point. Of course, there could always be a black swan event. But from a technician’s standpoint, we’re looking at a pretty decent risk/reward ratio when looking at the technical.

 

As we said, we’re following the data.

 

Speaking of data — we’re committed to bringing you our interpretation of market data every Wednesday on YouTube Live during our Weekly Market Insights broadcasts at 3:30 p.m. CT.

 

Be sure to subscribe to our YouTube channel and tune in each week to hear how we adapt clients’ portfolios and our investment thesis for the upcoming investment horizon. We’re here to help you make sure you’re doing the right things to preserve your wealth, which is part of our mission to help people become and remain financially self-reliant.

 

—–

 

Disclosures

Securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.

 

The opinions expressed are those of John Gatewood as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended to endorse any specific investment or security.

 

Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss. With fixed income securities and bonds, when interest rates rise, bond prices usually fall because an investor may earn a higher yield with another bond. Moreover, the longer the maturity of a bond the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. At maturity, the issuer of the bond is obligated to return the principal (original investment) to the investor. High-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase and reverse repurchase transaction risk.

 

Investors should be aware of the risks of investments in foreign securities, particularly investments in securities of companies in developing nations. These include the risks of currency fluctuation of political and economic instability and of less well-developed government supervision and regulation of business and industry practices, as well as differences in accounting standards.

More of the Same Ahead

Inflation conversations came to a head June 15-16, when the Federal Open Market Committee met and announced the Fed’s new monetary policies. The meeting consisted of 12 individuals — mainly board governors and some representatives from local banks.

Image of Federal Open Market Committee, including 2021 committee members names and titles: Jerome Powell, John Williams, Thomas Barkin, Raphael Bostic, Michele Bowman, Lael Brainard, Richard Clarida, Mary Daly, Charles Evans, Randal Quarles, and Christopher Walker.

The committee target three essential topics during their meeting:

  1. The committee decided to keep the target range for federal funds rate at 0-0.25 % until maximum employment.

  2. Inflation has risen to 2%, and it is on track to moderately exceed 2% for some time.

  3. The Fed will continue to increase its holdings of Treasury securities by at least $80 billion per month and agency mortgage-backed securities by at least $40 billion per month.

Even though we are above the target inflation rate, the graphs below show inflation well above 2% and trending down.

Graphs showing inflation over time.

In addition, the Federal Reserve will continue to increase its holdings of Treasury securities and agency mortgage-backed securities until substantial progress has been made toward the committee’s maximum employment and price stability goals. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

 

It’s also worth noting the dot plots below. Here, you can get a sense of the opinions of the 12 members of the Federal Open Market Committee. They believe the Fed will increase rates in 2023, and the central bank will hike at least twice that year. Only five members still see the Fed staying put through 2023, and seven of the 12 members see the Fed possibly increasing rates as early as 2022.

Dot plot graphic measuring opinions of the Federal Open Market Committee.

 

Indexes of the Market

Let’s look back 20 trading days at the different indexes of the market; we see NASDAQ (red), the 7-10 year treasury interest rate, the S&P 500 small-cap, copper, and gold (two bottom lines).

Graph showing the behavior of NASDAQ, treasuring interest rate, S&P 500 small-cap, copper, and gold.

On June 16th, copper, gold, and the S&P 500 small-cap were already trending low, and they sold off going into and after the FOMC meeting.

 

Inflation at Risk

Inflation is undoubtedly a risk, but we’re trying to understand what the market is doing. We’re talking about possibly raising interest rates in two years if inflation is still high.

 

Going back to the beginning of the 21st century, we’ve been at a zero federal funds rate most of the time.

 

Federal funds rate

The interest rate banks charge each other to borrow or reserve extra funds overnight.

 

From 2008-2016, we slowly saw an increase — until 2020, when we went back down to zero. The Fed has historically kept these interest rates low over time, and we don’t believe that will change going forward.

Graph showing effective federal funds rate from 2002 to 2021.

So, let’s go back to inflation. You might expect inflation to be low over the time we’ve been at a 0% federal funds rate, but it has not necessarily been low. We see the 16% Trimmed-Mean Consumer Price Index (CPI) as a measure of core inflation calculated by the Federal Reserve Bank of Cleveland. The Trimmed-Mean CPI excludes the CPI components that show the most extreme monthly price changes. This series excludes 8% of the CPI components with the highest and lowest one-month price changes from each tail of the price-change distribution resulting in a 16% Trimmed-Mean Inflation Estimate.​

Graph showing Trimmed-Mean Consumer Price Index.

Therefore, inflation is not necessarily shown in the data, and I don’t think the Fed will respond by raising interest rates. They’ve kept rates down to near 0-25 basis points, but the market responds as if this is a hawkish statement.

 

In conclusion, GWS believes that the inflation risk is undoubtedly high, but we don’t see a pause in inflation. Remember, high prices solve high prices, and we have seen commodities pullback before.

 

——

 

For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

Economic forecasts set fourth may not develop as predicited and there can be no guarantee that strategies promoted will be successful.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance references are historical and are no guarantee of future results. All indices are unmanaged and may not be invested directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

 

All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

Radical Transparency

Lately, we’ve been getting several questions from clients regarding the performance of our taxable accounts. While we can’t publicly publish performance numbers due to legal constraints, we are always happy to walk you through your portfolio’s performance in detail! Just contact your lead advisor if that is something that interests you.

 

In the meantime, we can share our approach to structuring our taxable accounts: our tax-sensitive, wide mode, and builder strategies, to be exact. Now, you’ll have a line of sight into what goes on behind the scenes with your money.

 

Full warning, this is going to be a deep dive! We’ve done our bests to make these concepts graphics-oriented, but this topic does require a fair amount of data and tables. So hang with us.

 

How We Measure Performance

To start, let me set the stage that all the numbers you’re about to see are based on hypothetical accounts. Everyone’s account won’t always reflect these traits; they are simply the theoretical models to evaluate performance against benchmarks. That way, if our portfolios aren’t tracking the way we expect, we will know why.

 

How do we monitor our account performance? We’ve made it simple with the acronym S-A-M-U-R-A-I:

 

Specified in advance

Appropriate

Measurable

Unambiguous

Reflective of current investment options

Accountable

Investable

 

Throughout this blog, we’ll walk through examples of how we monitor performance — using only the highest Chartered Financial Analyst, CFA, standards.

 

Manager Selection

Regarding manager selection, our approach is generally to ask, “Did you beat your benchmark or not?” And, more importantly, “What benchmark did you choose to measure it against?”

 

Any easy way to think of this concept is pictured above. Look at the big box (above) as our benchmark, with increasing performance and excess return. The excess return can either do better or worse than the benchmark. For example, over the last five years, there has been a negative access return.

 

Asset Class Domes

Asset class domes are the mix of stocks and bonds in your portfolio. These can exist across all asset classes, but the math gets more confusing each time you add additional asset classes. For this example, let’s consider a 60/40 portfolio.

At GWS, we generally recommend overweighting equity and underweighting fixed income, especially given today’s inflation risk. If you’re in bonds, you risk eroding your principal and purchasing power.

 

So, if you had a risk profile that suggested you should be a balanced investor, GWS would likely recommend an 80-20 allocation but measure it to a 60-40 benchmark. Then, you have precise data to use to analyze if our active weights helped or hurt performance.

Another way to look at this is with a bar chart. On the left, you have stocks, where we have 80% vs. 60% in the benchmark and 20% bonds vs. 40% bonds. Then, if you get into more detail, you can see the net difference of 20% positive and negative. That’s the way we look at portfolios; what’s the net relative to the benchmark?

Now let’s look at the effects of performance. For example, we have stocks performing at 12% and bonds performing at 4% in our hypothetical with weights.

 

We would say stocks multiplied by 60% equals an 8.8 in benchmark between the stocks and the bonds. But 7.2% of that 8.8% was attributed to equity performance. Then, if we look at bonds, we get 160 basis points.

 

Now, let’s look at our 80-20 allocation. We added 20% extra to stocks, resulting in a 9.6% return for our equity position and 0.8% for our bonds. That’s 10.2 vs. 8.8 — meaning investors are pretty happy relative to their benchmarks.

 

——

For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

 

Disclosures:

 

All examples are hypothetical and are for illustrative purposes.

 

The opionions voiced in this material are for general information only and are not intended to provide specific advice or reccomendations for any individual. All performance references is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

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Testimonials Disclosure

The statements provided are testimonials by clients of the financial professional. The clients listed have not been paid or received any other compensation for making these statements. As a result, the client does not receive any material incentives or benefits for providing the testimonial. These views may not be representative of the views of other clients and are not indicative of future performance or success.