Can All This Volatility Actually Help Your Portfolio?

Last year was near perfect for the markets — the S&P 500 not only gained over 21%, it also was the first year in history that the index didn’t experience a single down month. This year, however, is noticeably different. A rocky beginning may have you wondering if the long-running stock rally is over, though that’s not necessarily the case. In fact, the volatility may actually be a blessing in disguise.

Are You Ready to Bear the Full Brunt of Volatility from Equity Markets? Consider Fixed Income Ahead of the Market’s Next Downturn

What is the role of fixed income in your portfolio? There are two key considerations for fixed income that all investors should understand.

First, fixed income’s role is not diminished by what may be greater hurdles in the future (ie. rising interest rates). When the next downturn comes, we fully expect fixed income to outperform equity assets.

Second, price returns of bonds are not the whole story. Remember, what you glean from a month-end investment statement is only part of the narrative.

How did we arrive at these findings? Let’s take a look at what brought us here.

What Do Tariffs and Trade Wars Mean for Investors?

What You Can Expect and Resources from Fi3

Talks of tariffs and trade wars dominate the news. But what does this mean for investors? Market returns have been far more mixed and volatile in 2018. There are several factors involved, the most recent being rising tensions over trade between the U.S. and China. A series of recently announced tariffs has increased concerns for a broader trade war, which has impacted the markets.

The Impact of Recent FERC Announcement on MLPs

The Ruling May Revitalize the Discussion Surrounding MLPs Changing Corporate Structure

The Federal Energy Regulatory Commission (FERC) recently announced changes to the way certain Master Limited Partnerships (MLPs) set rates, or prices, for their services. Partnerships that transport crude oil or natural gas, and also operate on a cost of service basis, specifically are impacted by this ruling. Cost of service contracts allow an MLP to set rates and provide a constant return to equity and debt holders.

Historically, a component of this return comprised a tax allowance that all midstream companies could take. The ruling by FERC reversed this allowance, stating that parent companies can only use the allowance if they are actually paying those taxes. The market responded unfavorably to this news. While the announcement and ruling surprised the market, we suspect the hasty market reaction resulted in many investors selling first and asking questions later. Below are our key points and takeaways from the announcement.

• Who is Impacted? The FERC ruling only impacts FERC regulated interstate oil and gas pipelines which operate cost of service contracts. MLPs that do not operate these types of contracts or those that do not transport across state lines are not impacted. Additionally, the rules are unlikely to affect pipelines transporting liquids until 2020. It’s important to note, this will not affect negotiated rate pipelines, market-based pipelines, pipelines held in C-corps, and gathering and processing assets. Harvest Fund Advisors estimates suggest the EBITDA at risk for the Alerian MLP Index is merely 3.1%[1].

• What is the Impact? The tax allowance makes up approximately 5-10% of the whole tariff for regulated pipelines. While this will materially impact a limited number of names in the space, other assets will remain unaffected by the announcement. Given the unexpected nature of the announcement, information is still being collected. However, many major MLP companies have provided press releases around the materiality, or lack thereof, for their business.

Does this Change the Nature of MLP Contracts? No. There will be no material follow-on effects of how contracts are set between pipelines and their counterparties. Pipelines operating a cost of service model are generally at least 10 years old. Given the market has already shifted away from this type of pricing, the ruling will not create a fundamental disruption to companies’ business models.

• What is Our Outlook? Our assessment of value in the asset class remains unchanged. While the group has been out of favor, it remains an area that provides diversification from traditional stocks and bonds, protection from inflation and higher forward-looking return expectations.

We will continue to monitor developments as more details emerge and additional commentary is provided on potential impact at a company-specific level. This ruling is likely to revitalize the discussion surrounding the MLPs changing corporate structure to a C-corp. While the C-corp midstream companies are untouched in this ruling, it remains a single point of consideration for a long-term decision by company management. As details and clarity emerge, we will continue to assess the overall long-term impacts.

Please feel free to contact any of our professional advisors at Fi3 for more information. 

[1]Harvest Fund Advisors, March 2018
 

Federal Reserve Raises Rates

Investors Should be Patient and Stay the Course with Portfolio

As expected, Federal Reserve officials raised the federal funds rate 0.25% to a range of 1.50% to 1.75% last week at their March meeting and reiterated their forecast for a total of three rate hikes this year. The committee upgraded their forecasts for GDP and unemployment for 2018, citing stronger economic activity and tighter labor market trends. Fed policymakers revised their GDP forecast higher by 0.2% to 2.7% and expect the unemployment rate to decline to 3.8% by year end. The committee previously forecasted unemployment would be 3.9%. In step with the improved growth outlook, Fed officials raised their forecast from two to three rate hikes in 2019.

Here are several key points investors need to keep in mind: 

• Federal Reserve policymakers remain on track to raise the federal funds rate three times in 2018. This is consistent with median expectations for 2018 released last December and is in line with market-based estimates observed in federal funds futures contracts. The full impact of fiscal policies, such as the recently passed tax bill, changes to foreign trade, the Fed’s balance sheet reduction program and increases in the federal funds rate, will take time to flow through economic channels. In addition, the interplay of these changes could make the path of monetary policy normalization less discernible going forward. However, absent material impacts from these policies, improving labor market and inflation trends are supportive of three total rate increases this year. Market implied estimates are still forecasting two rate hikes in 2019.

• U.S. equities were mostly unchanged on the day of the Fed announcement because the move was widely expected. The committee's upgraded forecast indicates they are raising rates for the right reasons – namely tightening labor market conditions and accelerated economic growth. Furthermore, global monetary policy remains largely accommodative. While we consider potential impacts of future Fed policy decisions on equity markets, we believe the dominant theme driving equities in 2018 is the continued synchronized global growth trend that gained momentum in the second half of 2017.

• The Treasury curve steepened modestly with the 2-year/10-year spread rising 0.05% to 0.59% as higher long-term rates outpaced increases in short-term maturities. The yield curve continues to be relatively flat at levels traditionally associated with tight monetary policy. However, real rates remain low by historical comparison and are still stimulatory. Looking ahead, policymakers will assess potential impacts from expected treasury supply issuance and wind down the Federal Reserve’s balance sheet, an event which has no precedent. Investors will focus on how these two policies influence credit spreads and longer-term interest rates. Fed policymakers are likely to take a “wait and see” approach should either experience a sustained increase. Importantly, these forces are not new but do present more variables for data-dependent Fed policymakers.  

We believe investors should be patient and adhere to a well-constructed, diversified investment portfolio anchored to your goals and time horizon. Despite elevated uncertainty, we do not find compelling reasons at this time that would justify overriding our asset allocation methodology. 
 
Please contact any of our professional advisors for more information and assistance.

 

 

Fi3 Financial Advisors Partner Samuel Muse Receives the Indiana CPA Society’s Emerging Leaders Award

Samuel Muse, CPA, CFP®, is one of five Indiana CPAs being presented with a 2018 INCPAS Emerging Leaders Award.

“We are incredibly proud of Sam for being named an Emerging Leader by INCPAS,” said Ivan Hoffman, Managing Partner of Fi3 Financial Advisors. “Sam works diligently to uncover and analyze new opportunities for our clients. He serves as a Family CFO, which means that he must integrate wealth planning, investment consulting and family leadership for a comprehensive and seamless client experience. This is a challenging but rewarding role, and we are glad to see Sam recognized for his capabilities.”

 Sam Muse, CPA, CFP receives the 2018 Indiana CPA Society's Emerging Leaders Award.

The annual Indiana CPA Society Awards recognize CPAs with active licenses in good standing who have demonstrated excellence in serving the profession, company, community and public interest.

The Emerging Leaders Award was established in 2001 to recognize up-and-coming leaders in the profession. Each recipient must demonstrate leadership and initiative; have made significant contributions to their employer’s success; and be age 34 years or younger.

“CPAs are often the ones working behind-the-scenes to make their companies and clients more successful,” said INCPAS President & CEO Jennifer Briggs, CAE. “We appreciate the colleagues who noticed and nominated these members who have made truly exceptional contributions to the profession. The Society looks forward to spotlighting them at this year’s CPA Celebration!”

Winners for all award categories will be honored at the CPA Celebration at the Indiana Roof Ballroom on May 11, 2018. Categories include Advocacy, Building Bridges to the Profession, Community Service, CPA Center of Excellence®, Distinguished Service, Emerging Leaders and Innovation. Event details at incpas.org/celebration