Gail Sullivan Joins Aurora

We are pleased to announce that Gail Sullivan has joined Aurora Financial Advisors LLC.  Gail comes to us from North American Management (NAM) where she was a Vice President and Relationship Manager. Gail will continue in her role as a Relationship Manager at Aurora and will also be the Principal with overall responsibility for the functioning of our Westford office and for the services provided to clients through that office.

Gail is a very seasoned financial advisor, having first worked for a large New York investment bank, and then for 30 years as Vice President of First Lexington Capital Corporation.  When First Lexington was sold to NAM 6 years ago, Gail joined NAM to continue to work with her clients there.

Gail is a rare find in this day and age, coming to Aurora with an in-depth understanding of the financial advisory business.  Please join us in welcoming Gail to Aurora.

When “good” news can actually be “not so good”

On Friday, we were stunned with the news that the Bank of Japan (BOJ) had cut interest rates to minus 0.1 per cent. This may not have affected your “everyday” world but it did affect ours, as your advisor, and it will affect you as an investor in the future. Following this stunning, and actually negative, economic news, the markets responded with one of the strongest, positive days that we have experienced since last September. Given the history of such events, this not surprising but it is antithetical. The BOJ cut rates because it became very concerned that the slowdown in world markets, particularly emerging markets, and slumping oil prices would hurt growth in Japan, following the recent announcement that gross domestic product growth in the US slowed sharply in Q4 2015 to an annualized rate of 0.7%. This compares to China’s projected growth rate for 2016 of 6.7%! So, while the concern up until now has focused on slowing growth in the emerging world, its shift to the more resilient economies is now concerning central bankers. We have real concerns that deflationary pressures – which can lead to recession-like conditions – are now emerging and that actions such as those of the BOJ could trigger so-called currency wars as monetary stimulus in Europe and Japan negatively impacts exporters in the US and elsewhere. So, we saw little to be positive about following Friday’s announcement. It truly signaled longer term economic weakness. So, when equity markets respond positively to declines in interest rates, or a reduced likelihood that interest rates will rise, they will eventually respond to the underlying reason that such a move in interest rates was designed to counter – meaning that they will eventually respond to the fact that all of this signals a difficult time ahead for the world’s economies. In the short run, equity markets can run counter to underlying economic growth, but they cannot achieve this over the long run. Our slowing world economy will mean that we will struggle to see more than low, single-digit returns for the next 12 to 18 months with increased volatility and surprises to the downside. And as we expected, the markets, absorbing this move by the BOJ more rationally, have largely reversed Friday’s gains. In this environment, what do we propose to do?

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What are the “technicals” telling us?

Every day, market commentators attempt to establish some link between a key news story, or a domestic or international incident, and the performance of the markets that day. Examples are the Koreans’ testing of a nuclear weapon, Saudi Arabian executions which angered Iran, China’s devaluation of its currency, or a belief that growth in China is slowing with “guesswork” as to what the effects of the unknown might be. But the current over-riding problem in equities markets, in our opinion, particularly US equity markets, is over-valuation.

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Q4 2015 Newsletter

Our Q4 2015 newsletter is brief and to the point – or two points, actually. The importance of diversification – even when it appears to have hurt investors in the short run – and of investing for the long term – and ignoring short run market gyrations.

Let’s look, for moment, at the performance of the various asset classes in 2015. The first column is the index we use for the asset class in which part of your portfolio is invested. So, for instance, S&P 500 Growth is the index that we use for the US Large Cap Growth portion of your portfolio. Numbers in BLACK denote positive percentage price returns; numbers in RED denote negative percentage price returns. The second column is the total price return for the whole of 2015; the third column is the price change from the peak of the index in 2015; the fourth column is the total price return for the second half of 2015. This truly is a “sea of red”, and shows the extent to which 2015 was a very difficult year for investors, with no “place to hide”.

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The aftermath of the FED decision

It was pathetic to watch the markets and investor behavior in the minutes and hours after the FED announcement last Thursday that it would not raise its key interest rate. First, the markets rose for about 5 mins (good, interest rates will stay low!), then fell dramatically in the next 10 minutes (woe, the world’s economies are slowing), to rise, equally, in the next 15 minutes (now we are confused), before “taking off” and climbing by 0.9% from the price at the time of the announcement (yes, low interest rates ARE really good) – to collapse by market close falling 1.42% for a loss on the day of 0.28% (nothing has fundamentally changed!) Let me say this again, and I am sure that it will be repeated on further occasions, the FED raising the key interest rate in small controlled increments from the present value of ZERO is not going to have medium or long term deleterious effect on the equities markets. So what does all this price movement tell us? A combination of (a) traders and large institutions were unable to discern a clear message from the FED announcement or adopt a meaningful strategy from the FED decision, (b) the herd mentality was evident, and (c) the market was responding to sentiment not deductive reasoning.

Up and down, and sideways – there is no sense of direction

So we survived Wednesday 26th (the date of our last missive) – thanks to further Chinese intervention, a shift in the probability that the FED will act to increase interest rates in September, and the continuing good US economic news. Does that mean we were expecting a V-curve response, as we experienced in 2014, when markets fall rapidly and then rise equally rapidly? There was or is no reason for that to occur. We have been saying that markets are overvalued for more than a year; really since the end of 2013, and what we have been experiencing recently is typical behavior when there is a broader acceptance of this fact. The markets fall heavily, and then oscillate (dither)1 sellers “test” for a market bottom. There is no certain, scientifically calculable bottom. It is always determined by the aggregate behavior of buyers and sellers. The pattern that we have been experiencing, when the slightest bad news is accompanied by an outsized negative response, is normal in these market conditions. The tendency, in these circumstances, is to be more wary of the downside and more skeptical of the upside. Money “stays on the sidelines” and buyers “keep their hands in their pockets” or just do not extend their purchasing. There will always be relief rallies or brief upswings in response to days when equities and other securities are oversold, even in times when the general sentiment is negative. It is typical of a market that has yet to find its bottom.

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The Tuesday After

At the market close on Monday, we ran a report to see what had happened to the dividend yields of stocks over the last two volatile trading days. While we had expected to see some dramatic changes, we were taken aback with the effect that the recent market declines, and a long period over which many (for example, energy) dividend stocks had lost value, had had on dividend yields. For example, Chevron’s stock was down 44% from its 52 week high at the close yesterday, with the result that its projected next 12 month dividend would produce a yield of 6% at current market prices. That we have not seen in a mature, major oil company in memory. At the same time yesterday, the 10 year Treasury was yielding 2.03%. We know that oil prices could fall further. Many of you will have heard us say since January that, on a coin toss, we believe that there is a 50% chance that oil will be $60 per barrel by the end of this year or a 50% chance that it will be in the $30’s. And yesterday, it was in the $30’s. So could Chevron’s price go lower? Yes, but owning a stock such as Chevron, which in previous market declines has shown that it can sustain and grow its dividend, buys the right to, hopefully, a sustainable dividend stream which will be very attractive while bond yields remain so low. In addition, energy stocks have been beaten down, and can be expected to rise when oil prices normalize. When you combine this with the fact that income seeking investors will glom onto yields in the 5% to 6% range with “solid” companies, such as Verizon and AT&T, we can see that this desire for yield, when little exists elsewhere, will also have the effect of driving up the prices of such stocks, just as it did when we developed such a bond-replacement strategy in 2010/2011. So, particularly for those of our clients who are seeking and need income, the current situation presents an excellent opportunity to increase portfolio yields.

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A Day to Reflect

Today was a very difficult day for world markets. It was one of those rare days when we saw trading paused in a large number of stocks whose price behavior had triggered volatility thresholds. The DOW, in the first 30 minutes of trading, bounced between declines of 500 points and 1050 points. By 10.00am, however, the DOW losses had been reduced to 495 points or a loss of 3.09%. This was, of course, not good news but, instead, an indication of the chaotic and non-discriminatory (bordering on panic) opening trading that we have seen in the last few days. Someone asked me shortly after the day’s opening, when the NASDAQ had plunged nearly 9%, if this felt like “market Armageddon”; I responded by reminding them of the more than 20% one-day decline of the DOW in 1987 and said that this felt nothing like a similar situation.

Asian and European markets closed down for their day in the 4% to 5% range generally, with the Shanghai Composite Index down 8.49% to wipe out all of its gains for 2015. As the morning progressed, and as we passed the close of the European markets at 11.30am EST, the losses in US markets were pared dramatically. At noon, the DOW losses had declined to 1.24%, the S&P 500 to 1.85%, and the NASDAQ to 0.92%. But as we have seen with most intraday recoveries, the afternoon trading has not always held up. The recovery momentum went away and we fell to losses on the day of 3.58% on the DOW, 3.93% on the S&P 500 and 3.82% on the NASDAQ, much in line with the rest of the world, if a little lower, and once again supporting evidence for the increasingly global nature of our markets and our inability as investors to insulate ourselves from the vagaries of foreign markets.

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A Nervous Time For Investors

We can understand investors being nervous at this time, especially with the world’s markets experiencing their worst one day decline, this last Friday, and worst one month-to-date, since 2011. However, we are concerned that investors perceive risk whereas what they are actually experiencing is variability – a known, measurable and expected characteristic of their investment environment. Yes, markets are prone to react poorly to uncertainty – an unknown and non-measurable property of “life” and investing – but we do not see that what the markets are facing or reacting to in terms of uncertainty is any greater or worse than they have experienced in the last 7 years. So how should an investor view the events of the last few weeks?

Let’s use a hypothetical portfolio of $1,000,000 being managed to Aurora’s moderately conservative risk profile, with a long-run expected return of 8% and a value-at-risk (VAR) of 12% (actually it is 11.92%, but let’s approximate it as 12% for illustrative purposes, and we will explain this concept further below) compared to about a 19% VAR for the S&P 500. First, just because you looked at your account statement today, and it said your portfolio is worth $1,000,000, that only means that it is worth $1,000,000 today AND has a close to ZERO probability that it is worth $1,000,000 tomorrow. Let us explain what we mean by that: next day the markets will trade and at the end of that day your account will have experienced a loss or a gain, normally in the range of up by 0.75% or down by 0.75% for a moderately conservative account at Aurora. This means that there is only a small, if infinitesimal, chance that it will be worth exactly $1,000,000 next day.

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  • Portfolios experienced significant declines in Q3
  • The world’s equity markets underwent what is called a correction – a loss of more than 10% of their value
  • Even fixed income suffered in this quarter. Cash was King!
  • A quarterly reporting period is irrelevant for portfolios that are positioned for the long term
  • Equities rebounded in the first 11 trading days of October, reversing more than 50% of losses

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