British Pound At Lowest Levels Since 1985

The pound traded at its lowest levels versus the dollar since 1985, off 22% from its June high before the Brexit vote. The pound’s strength has become incredibly contingent on the outcome of Brexit, placing tremendous pressure on the currency at a critical time.

There has been a steady descent in the pound since the vote. Markets are concerned that as Britain plans its exit, which is expected to happen in the next two years, it will dramatically hinder the financial and banking sectors. The reason is that exports of British products to the EU might be severely limited once the exit has taken effect.

Britain’s current prime minister has expressed priority in limiting the influx of immigrants into England from the EU. This stance could very well become a significant issue with the EU, since not allowing immigrants from the EU the rights to access Britain would surely threaten Britain’s ability to trade and travel freely throughout the EU.

The most vulnerable sector to such retaliations are the financial and banking sector, which heavily rely on free movement of employees throughout the various countries in the EU. The financial and banking sector accounts for 12% of Britain’s GDP, a considerable portion of the economy. Since Britain’s economic future has become contingent on the outcome of Brexit, the IMF downgraded its growth forecast for the country, predicting that the British economy will only grow a paltry 1.1% in 2017. (Source: IMF, Bloomberg, Reuters)

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2016 Election Results

 

The financial markets embraced a Trump victory, sending stock prices to higher levels following a nine day consecutive decline in anticipation of uncertain election results.

Market performance following presidential elections have varied over the decades, however, Trump’s effect on the S&P 500 Index of 1.11% was one of the best for both Democratic and Republican presidential victories ever. Obama’s win in 2008 saw the largest drop of -5.27%, while Reagan’s victory in 1980 saw the largest gain of 1.77%.

U.S. Treasury yields rose dramatically with the expectation that a Trump presidency along with a Republican controlled Congress will inevitably ramp up government spending in order to boost economic growth. During the campaign, Trump was very critical of the Federal Reserve not acting to raise rates soon enough, insinuating political influence.

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Over 45% of Households Have No Retirement Assets

 

As the Baby Boom generation has begun to retire, more attention is being paid to retirement savings and how much retirees will have to live on. In addition to Social Security, a primary source of retirement funds for decades has been pension plans, also known as Defined Benefit (DB) plans. Over the years private sector companies have shifted away from traditional DB plans to Defined Contribution (DC) plans, including 401k Plans.

As employers and employees have shifted their assets from traditional pension plans to 401k plans, the onus of funding and managing these retirement assets has migrated to the individual employee. It used to be that employees were automatically covered by pension plans and funded on their behalf. Today, most 401k plans are voluntary and funded not by employers but by employees themselves.

Many believe that the shift from traditional pensions to 401ks has made it difficult for employees to save. When the average length of employment with a company was much longer years ago, it was feasible to have employers fund their employee’s retirement accounts. The benefit is also used as an incentive for employees. Modern day dynamics have made employees much more mobile, making 401k plans more popular and practical as retirement savings vehicles. (Source: National Institute on Retirement Security)

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The Strengthening Case for a December Rate Hike

Over the past year the economy has improved moderately, which has strengthened the case for a rate hike by the Federal Reserve. The Federal Reserve’s dual mandate is to foster maximum employment and price stability. This year, we have seen progress made on both fronts with the unemployment rate hovering at 4.9% (close to the Fed’s long-term projection of 4.8%) and core consumer prices up 2.3% versus a year ago.

The details of the Fed’s September meeting point to a growing probability of a December rate hike. In the meeting, three of the ten officials voted in favor of a rate hike in September. In July’s meeting, only one official voted to increase rates.  The September statement asserts that near-term risks to the economic outlook are “roughly balanced.” This is the first time the Committee has used this language since before raising rates last December, which possibly indicates a future rate hike. In the “dot-plot” projections released after the September meeting, fourteen of the seventeen FOMC members predicted that the federal funds target rate will rise by at least 25 basis points this year. There are two more meetings left this year: one in November and one in December.  Since the presidential election falls just six days after the Fed’s November meeting, and the meeting is not accompanied by a press conference, it is unlikely the Fed will take action then. This leaves the December meeting as the sole remaining viable option for a rate hike this year.

In addition, the Fed risks losing credibility if they postpone the next rate hike much longer. At the beginning of the year, Fed leaders projected they would raise rates four times in 2016. In the September meeting, that number was reduced to one. If they fail to increase rates at all, the Committee would risk further diminishing public confidence.

Barring any unforeseen developments, we believe the Fed is poised to raise rates in their December meeting.

 

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Domestic vs. Developed International Stocks - A Tale of Two Market Cycles

Domestic stocks have been a dominantly outperforming asset class over the past three years (see Scott Drown’s January blog titled “Di-worse-ification”). The results displayed on this graph prompted us to dig deeper into the performance of our domestic markets’ international counterpart, the MSCI EAFE Index. The MSCI EAFE Index is designed to represent the performance of large cap securities across 21 developed markets and is widely regarded as the “S&P 500 equivalent” to the developed international markets.

When looking back over the past 45 years, we were able to parse out the relative out-performance of the S&P 500 and the MSCI EAFE indices and have found that over several year periods, one index seems to substantially outperform the other but reverts back at a later period*: 

DATE RANGE

OUTPERFORMER: S&P 500 or EAFE?

% OUTPERFORMED

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