February was a month to forget in the investment world. Volatility finally returned and clients may want to hold their nose when they open their next statements. It was the worst month for the stock market in 2 years and our accounts were not spared unfortunately. The news that generated this bumpy month was growing inflation and higher interest rate concerns.
This was unpleasant, but not all that unexpected. Rates have been low and the market has been up for so long that eventually something’s got to give.
Growth Portfolio
Our Growth Portfolio, which is led by Matthew Coffina, CFA at Morningstar’s Stock Investor, continues to outperform. Even though it’s a more aggressive portfolio, it logged a smaller decline than the market in February of approximately 3% (depending on portfolio) to follow a great one-year performance.
We tried to make quite a few buys for those with cash as there were opportunities in the midst of the volatility. One sale was made to free up cash after the stock AmerisourceBergen ABC jumped on merger news. Future buys we’re considering from Morningstar’s list are Starbucks SBUX, Anthem ANTM and Enbridge Energy ENB. We’ll be looking to add those the next time the market has a pull back.
Moderate Income Portfolio
The less aggressive Moderate Income Portfolio, which is modeled after Morningstar’s Dividend Investor, continues to underperform due to the rate rise. Morningstar’s portfolio was down 6.5% and ours down closer to 5% in February. I believe it’s been almost 5 years since we’ve seen this kind of movement in this portfolio.
Our big problem with higher interest rates is not that they slow down home buying and the economy. Our problem is higher rates have adverse affects on bonds and the stocks of the more essential service industries like real estate, utilities, and telecom. These investments struggle with higher rates and they just happen to be the bread and butter of any income portfolio.
So, if rates are on the rise – for real this time – we need to position the Moderate Portfolio to weather the storm better (the Growth Portfolio is less affected). Below are three steps to help us do this:
- Move away from interest rate sensitivity – We’ve already begun selling some of the low yielding positions and moving the cash into Wisdom Tree’s Growing Dividend Fund DGRW. It has a dividend of just under 2%, but it’s less interest rate sensitive and captured all the growth of the stock market last year. We will continue to do this as we see opportunities.
- Allocate more to Growth – We’ve already moved a portion of some clients’ portfolio into the Growth Portfolio, but we want to discuss this with all the moderately risky clients as we make our upcoming calls.
- Exchange bonds for guarantees – The last step is moving bond positions into a fixed account. One bright side to higher rates is we can now get 3.1% per year for 5 years guaranteed. The downside is it’s more paperwork and less liquid. We think it’s worth considering moving some, or all, of the bond portion of client’s accounts to protect against higher interest rates.
The net result of these changes will be no additional risk, but a better return over our 10-year analysis. This will reduce income from dividends but should help us offset the share price loss while rates are on the rise. When rates are back to normal – back above 4% on the 10-year treasury – we would look to maximize dividends once again.
Other News
Last weekend, I (Tim) got the chance to head to Seattle to be nominated for Reserve Enlisted Person of the for the Coast Guard. To my shock, they chose me to win the award for District 13 (Pacific NW) for my work as a Coxswain (boat driver), my work in leadership, volunteer work and education. It was an honor just to be nominated and even more of an honor to win. I’m now entered to win the award for the entire Coast Guard with the other 8 winners from around the country. I don’t know the exact details of when that will be decided, but I’ll be sure to pass along the results when I hear.
Finally, we had a great time at our open house last Wednesday. All of us at SMB want to thank everybody who came out and made it festive! We look forward to having the rest of you out to see the new space at our next meeting.
We’ll be working through our call list to try and talk with every client before tax time. We look forward to talking with you, but if something comes up before then, please don’t hesitate to contact us.
-Tim Porter, CFP®