Skip to main content

Mercer Advisors Capital Markets Update and Outlook: July 2019


Welcome to this Mercer Advisors Client Seminar. Today, we will discuss the capital markets for the first half of 2019. The day that we’re going to discuss today is through June 30th. Our goal with this broadcast is to inform you about the progress of the financial markets in real time, and also discuss topics that are meaningful to how we’re managing your money. We also want to answer your questions. We appreciate you taking the time to join us today.

My name is Doug Fabian and I’ll be facilitating today’s program. I’m a Science of Economic Freedom podcast host and part of the client communications team here at Mercer Advisors.

Now, here are some tips to improving your experience on today’s call. There’s a toolbar on your screen for those listening live. You can move the location of the toolbar or even close it altogether using the orange arrow at the top of the toolbar. Some of the slides we will be sharing with you have important information on the right side of the screen, so closing the toolbar or moving it over to the left may be helpful.

Now, there are some additional functions on the toolbar. This is where you could submit a question. It will send us a text message and we’re going to do our best to facilitate as many questions as possible during the Q&A portion of today’s presentation. Now, our formal program will last approximately 40 minutes, and leave 20 minutes for Q&A.

Joining me today is Don Calcagni, our Chief Investment Officer of Mercer Advisors. Now, we take our jobs as fiduciaries seriously and we work in a highly regulated industry. The purpose of this disclaimer is to say that we’ve taken great care to bring in data from reliable sources. Now, no part of this presentation should be considered personal investing advice and you should discuss any changes to your financial plans with your Mercer Advisors client.

Here’s our agenda today. First, we’re going to have a discussion about the financial markets and how they’ve performed so far this year. Next, we’re going to review how the economy is doing. Lastly, we’re going to discuss Mercer Advisors’ approach to managing money and fixed income. After that, your questions will follow.

Now today, we have our Chief Investment Officer, Don Calcagni, to lead us to a variety of topics. Don began his career as a client advisor 15 years ago at Mercer. He did his graduate work in finance at the University of Chicago, and has been in his current position as Chief Investment Officer for the past five years.

Don, great to have you with us today.



Thank you, Doug. It’s great to join everybody today, and thank you to everybody for taking time out of your day to join us.



Don, I wanted to begin before we get into our agenda today to just explain to our audience how we work in terms of our Investment Committee and your role as the head of that committee.



Sure. At Mercer Advisors, we have a 14-person Investment Committee, and there are two halves to that Investment Committee. The first half is what we call the Investment Advisory Committee, which consists of client-facing individuals from across the organization. The second half of the Investment Committee was what we call the Investment Operating Committee, and that’s the group that meets day-to-day to implement investment decisions across the organization. We focus on things like operations, and trading, and things like that.

The whole purpose of the Investment Committee, first and foremost, is to uphold our fiduciary responsibility to our clients, and that begins with establishing the firm’s investment philosophy, and then from there, building strategies and portfolios for our advisors to use when working with our clients, when working with all of you who have joined us today. Our Investment Committee, finally, is also responsible for hiring and firing of the managers who physically implement those different strategies on our behalf.



Let’s talk about our client advisors and their interaction within the investment team and how that approach works here.



The client advisors, and first off, the investment advisory committee, those folks are client advisors, they are client facing, and so the idea there is we want to have real-time feedback from our clients by way of our advisors with respect to what do they need, what are they looking for, what are their concerns. Our advisors also interact with our Investment Strategy Group, which is a team of CFAs, or CFA Track individuals, or MBAs that support all of the advisors across the Mercer Advisors organization. In the event that the advisor has a complex case, or the client is trying to solve a particularly difficult tax, or investment related challenge, they bring that case to our team, and we take the best minds in the company, and put them on solving those cases.



Talk to us about the Mercer Advisors’ investment philosophy.



At Mercer Advisors, we view ourselves as the Mayo Clinic of the wealth management profession. When you think about the Mayo Clinic, if you’d go to the Mayo Clinic, you’re working with a team of experts across a wide range of medical specialists. If you’ve ever had an experience where you’ve had to engage, for example, a health care professional, when you go to somewhere like the Mayo Clinic, they are using the absolute best science available anywhere on planet Earth to help diagnose and cure your condition.

In reality, that’s how we approach investing at Mercer Advisors. There is a science to investing. Investing doesn’t have to be this circus-like spectator sport that the media often makes it out to be. There is a science to investing. At Mercer Advisors, everything we’re doing in your portfolios, I can assure you, is fully validated by many, many decades of academic research. We maintain very close relationships with academics across the United States with respect to ongoing research in mathematics, and financial mathematics, and portfolio management.

We view ourselves as having that same responsibility as a physician who is charged with taking great care of his or her patients. We view ourselves as having that same degree of fiduciary responsibility to our clients. We will never do anything in our portfolios that we cannot support with a significant amount of high quality academic research.



Great. I think that that just sets a great context for everyone on the call today who really understand how our investment philosophy is different, and how our firm works differently than many other firms out there in terms of how our Investment Committee sets strategy, and gives our advisors lots of options. With that introduction, let’s jump in today’s presentation.



Great. Let’s just begin by taking a broad view and looking at equity market returns over the past and so far year-to-date, and that says 2017 or 2018. I apologize for the typo. But if we just look at year-to-date returns, I just want to draw your attention to here. So far year-to-date, the US equity market, the S&P 500 is up 18.5%. Now, mind you, that’s coming on the heels of fourth quarter 2018, which admittedly was a pretty rough quarter.

We saw a market correction in the fourth quarter of last year. Certainly, clients were concerned. Last year, we see that US equity markets returned to -4.4%. This is why we’re constantly advising clients to remain diversified, stay invested. Markets go up, markets go down, rebalance your portfolio, work with your advisor, don’t try to time the market. We have seen really, really strong equity returns obviously so far year-to-date.

But not just in the US, even outside the United States, we are seeing double-digit returns typically in the low to mid-teens across most global markets. You guys have often heard us recommend that clients should remain globally diversified. Well, that’s why, right? Economically outside the United States, the planet is growing more rapidly than the US economy, and we want to participate in that growth.

So far year-to-date, equity market returns have been phenomenal. Before I go off to this slide, I just wanted to touch on the global equity market. The US financial market, the US stock market makes up about half of the global market. What you should take away from this graphic is that, yes, the US is a big place, but the world is an even bigger place, and there’s a lot of other markets that you definitely want to participate in to help manage risk and grow your wealth.



One other comment I want to add is that we’ve continued to have good performance in the equity markets here in the month of July with the S&P 500 up an additional 3%.



Indeed, we have. Indeed, we have. This begs the question. Many of you know that at Mercer Advisors, we take a very scientific approach to managing portfolios and you often hear us talk about what we call factor investing. Factor investing is just another term for scientific investing. If you were to take a business, of course, in portfolio management at say Wharton, or Chicago, or Harvard, this is how they’re going to refer. These are the things they’re going to teach you with respect to help best build a portfolio.

Year-to-date, factors have actually done pretty well. Some have done well, some have outperformed the broader market, some have underperformed the broader market. But all of them have actually posted very nice, handsome returns year-to-date. The quality factor, which returns generally to companies with very high operating profits, that’s an accounting measure, those types of companies have returned almost 22% so far year-to-date. We do have quality companies in our portfolio, so that’s one of the factors that we diversify into when we build and manage your portfolio.

Momentum, these are companies with very high price appreciation relative to their peers over the prior 12 months. This could be your FANG stocks. Back in the 20th century, it would have been a company like Sears. Today, it’s a company like Amazon. Momentum stocks are up almost 20% so far year-to-date.

We have these things called minimum volatility stocks. These are defensive stocks. Defensive is a retail term, but what it really refers to is these are companies that for whatever reason, when the market declines, they tend to decline less than the broader market. They tend to be companies that have less debt relative to their peers, so they’re not as heavily indebted, let’s say, some of the other companies that are trading in the market.

In the middle of the pack here, we see the S&P 500 Index coming out at 18.5%. In terms of underperformance, we see that small companies have slightly underperformed US large companies that S&P consists of the 500 largest companies in the United States. Small companies have underperformed by about a point and a half. We see that a more diversified multifactor strategy has underperformed a little bit so far this year and that’s largely due to the fact that it owns some value stocks, as well as probably some high-yield dividend stocks, and value has underperformed probably by about 5% here so far year-to-date.

But before we fixate on the underperformance of those three or four factors, and suddenly, we all want to chase and just own the quality momentum and minimum volatility factors, let’s just back up for one moment. We have to be careful of chasing performance. Chasing performance is not good for our financial health.

It’s always important to look at factor returns over longer periods of time. I want to draw your attention to the average annual return for the past 15 years for these different factors relative to one another and we can see that at the top is momentum, we see multifactor all coming in 9%, 10% per year, minimum volatility quality. Even value, value has been very unloved here for the past 10 years, but over a much longer periods of time, the performance of value stocks, these are companies with low prices relative to some fundamental, so it could be earnings, it could be their assets or some other metric. But over longer periods of time, value has outperformed quite handsomely.

We see here towards the bottom is actually the S&P 500 Index. The factors that we invest in, by and large over time, outperformed the market, not every time, but over time, very important to keep that in mind. We notice here at the bottom is something called small company stocks, and small company stocks have underperformed the S&P very slightly by about 0.3% over the past 15 years.

What we notice if we look to this final column on the right, this is a measure of volatility. It’s just a fancy word for risk. Higher risk obviously makes us uncomfortable. Lower risk makes us more comfortable. We see that these small company stocks have actually had the highest risk over the past 15 years, yet pretty much gave us the same return as the S&P with a little bit of underperformance. That kind of SKU is not something that you see persist very long in financial markets. Not to predict the future, but if I were to predict anything, I would predict that that will probably start to see a regression back to the mean where small companies eventually will start to outperform the broad market eventually.

But Doug, I just wanted to end there and just highlight that over longer periods of time, almost all of these factors have outperformed the broad market quite handsomely.



Two things to add here, Don. One is, we’ve talked about this before, when you have a diversified portfolio, there’s going to be some segment of your portfolio that underperforms a bit. Looking at our strategy over the last 12 months, that would be small caps that has been underperforming. But as you can see, there are some other years here that small caps were top performers.



Absolutely. This is the beauty and the challenge of diversification, and we’re going to touch on this here in a little bit. When you’re diversified by definition, you own a whole bunch of stuff. What that means by definition is you’re going to have some rock stars in your portfolio and then you’re also going to have some underperformers in your portfolio. But the beauty of diversification is because that we can’t time returns across these different types of assets.

What actually happens mathematically, and again, we’re going to touch on this here in a few moments, is it smoothes out the risk in the portfolio. I’m going to teach our audience here in a little bit that the future value of your wealth is a direct function, not just of returns, but equally or actually more importantly, the risk in your portfolio. We got to be careful not to be chasing yesterday’s winners because that is a recipe for financial [Inaudible 00:15:28].

Sorry for the slight delay there, folks. Here we are. We’ve seen equity markets really recover since the market correction in the fourth quarter and when you start to see equity markets up 18.5%, I think the natural question that certainly I have when I’m discussing things with our investment committee is, “Hey, what do market valuations look like?” Our stocks getting overvalued, right?

Doug, I think when we look at the data, we see that stocks are not overvalued by any objective measure. The long term, meaning for the last 20 years, the price-to-earnings ratio for the S&P has been just a little bit over 16 times next year’s earnings, and that’s this perforated line that you see here in the middle of the screen. The S&P 500 is trading maybe just slightly above its long-term average.

When I look at the data, I don’t see any evidence here that stocks are suddenly wildly overvalued, for example, like they were in the late 1990s. Arguably, that’s when the market actually peaked. We had companies like trading at a million times earnings. Those things just made zero sense. Again, just looking at the data, not seeing a lot of evidence here that markets are wildly overpriced.

I think it’s important to keep in mind that one of the reasons why stocks aren’t really overpriced is the economy continues to grow. The US economy is growing at right around 3% per year. You know what’s interesting, Doug, is this time last year, we’re all predicting recession, recession, the economy is slowing down. Sure, the economy did slow down a little bit, but it slowed down from like 3.5 to 3.2. We’re still talking a pretty healthy economic expansion.

What’s interesting is outside of the United States, the global economy is growing. Quite handsomely, the emerging markets are growing just under 5% per year, right around 4.8, 4.9 a year, and developed markets are growing at around 3.3% and 3.5% a year. It just depends on which market we’re looking at. Globally, we’re seeing very healthy economic growth. The US economy continues to grow. When we actually look at economic activity in the United States, what really drives the US economy is all of us. It’s all of you, all of you who are listening on the phone. It’s consumers. It’s consumers spending. It’s when you go out to eat with your spouse. It’s when you buy a new car, or you go clothes shopping, or you take that nice summer vacation to the shore.

Consumer spending is really driving our…what I consider to be fairly healthy economic growth. We have low unemployment, pretty low inflation. We’re even seeing some growth in wages. It’s almost a little too good to be true, some of the data, which always gives me a little pause sometimes to…trying to keep things in perspective. But by any objective measure, the economy looks like it’s in pretty decent shape.

In my view, in our view, I think the most important component of the US economy is the financial health of US households. It is absolutely critical that American households feel wealthy, that they are wealthier, that they are not drowning in debt. When we look at the data, this upper right-hand chart here that I want to draw your attention to, this is household debt as a function of personal income, disposable income. What you’ll see is since the financial crisis, US consumers really deleverage. They paid off credit cards or they paid them down. They refinanced their homes. They paid off their cars. They were even owning their vehicles longer than they were prior to the financial crisis.

Today, we have household debt levels that, frankly, are at the lowest point since sometime before 1980. US consumers are in a pretty healthy shape. When we look at household net worth, what we’ve seen here is we are…household net worth for the average American household is at an all-time high. Americans are wealthier today than they have ever been in their history.

Now, again, these are averages, and I fully respect and understand that not everybody has participated in the economic expansion, that there are parts of the country that are in pain, and that are struggling. Again, I’m just sharing with you here very broad averages. As long as the US consumer is by and large on average in good health financially, it’s reasonable to expect that the US economic expansion could continue.

Let’s talk about the bond market. I know, Doug, we’re going to spend some time here talking about Mercers’ approach to fixed income investing, but we are really having a great year in that. Both stocks and bonds have actually done very well so far year-to-date. This here is the US Aggregate Bond markets and so far year-to-date, that has returned a little over 6% through the end of June. That is a very healthy return. In fact, I would argue that is an above average return for bonds.

One of the reasons we’ve seen that, if you remember last year, the US Fed was raising interest rates and that was pushing down, it was suppressing the price of bonds into the market. It was right after Christmas when US Fed Chairman Jerome Powell began the hint that they were going to slow down on raising those rates. Even today, the Fed is meeting, and the bond market is pricing in a quarter of a point reduction in rates. Now, we’re not going to know that until a little bit later this afternoon. But if that happens, that could also help push up on prices. We’re seeing pretty good returns pretty much across the board, even outside the United States when we look at different bond markets. Again, bonds are doing well, equities are doing well, and definitely a good year so far for diversified investors.

The second half of our discussion today is really going to focus on what is Mercer Advisors’ approach to fixed income investing. Doug, do you want to maybe take a second here and maybe set the stage for this discussion?



Well, one of the things we want investors to understand is that almost every client that Mercer Advisors has some sort of fixed income allocation. What we want to do today is talk about how we here at Mercer Advisors go about managing money in fixed income. Because we can think back to 2018 when the Fed was raising interest rates, we heard from a lot of clients we’re concerned about their fixed income allocation of whether or not that was going to take a big hit because the Fed was raising interest rates.

We want you to understand today what the logic is, what the factors are that go into building a fixed income portfolio within Mercer Advisors, within that portion of your portfolio that’s dedicated to risk reduction. We also want people to know that the fixed income market is big. Fixed income markets worldwide are larger than the stock markets and they are very diverse. There are many different types of fixed income vehicles and we only use a specific type of fixed income investments in our portfolios. With that, let’s jump in to how we go about managing money in the fixed income arena, Don.



First and foremost, it’s important to keep in mind that at Mercer Advisors…and by the way, our view mirrors what you’re going to find in the academic community. We view the purpose of bonds in a portfolio. The primary purpose of bonds in a portfolio is, first and foremost, to reduce risk. It’s not to chase return and we’re going to talk a little bit about that here in the next few moments, but I did want to just reiterate something Doug mentioned here a moment ago.

Globally, the bond market is almost twice the size of the global stock market. The bond market globally is absolutely massive compared to the global stock market. There’s definitely a lot of choices out there, but to Doug’s point, we focus on a very specific subsection of the global market because again in our view, the purpose of bonds is to reduce risk, not to chase or hunt for return.

First and foremost, when you think about investing, investing is a very difficult exercise. We are all human beings. We are an emotional species and the idea behind owning bonds is to reduce risk in the portfolio. One of the reasons why the average investor in the United States significantly underperforms is because they’re constantly trying the time markets. They’re trying to always look for the hot stock, or the hot fund manager, or the hot asset class, and the reality is this bad behavior results in a substantial penalty relative to just taking a buy and hold and rebalance approach to owning stocks and bonds.

The whole idea behind bonds is to dump in the volatility to take that risk out of the portfolio, so that as human beings, as investors, we can sleep at night. That’s first and foremost, to earn good returns on your portfolio, we have to hold a portfolio, and be comfortable with what we’re holding, and be able to sleep at night. Bonds help us do that.



Don, one of the things that we have seen throughout stock market history or throughout capital market history is investors piling into certain asset classes when it seems like every indication is that asset class is going to continue to perform well going forward. Then the opposite is true where investors will flee a certain type of asset when it looks like that asset is no longer going to perform. What we have here on the screen is what we call the greed-fear cycle. This is why science matters in our investing portfolios because we have this human tendency to want to override science and do what we think is right because we’re being influenced by all kinds of emotional factors where emotion really don’t belong in the investing decisions.



Yeah. It’s absolutely right. Like I said, we are an emotional species and we have this confusion. We often confuse anecdotes with evidence. What do I mean by that? I had an Uncle Pete who lived to 100 years of age and God love him. He ate pork rinds, deep-fried pork rinds every single day, smoked cigars, drank whiskey. Because he lived to 100 years of age does not mean that we should suddenly take up smoking cigars, drinking whiskey, and eating deep-fried pork rinds everyday, right? The opposite to that would be… We’ve all heard of the tragic story of maybe an Olympic athlete who’s 25 years old in the prime of his or her life, zero body fat, works out everyday, eats healthy, and they tragically dropped dead of a heart attack. That doesn’t mean we should stop working out and follow my Uncle Pete, right?

It’s the same thing with assets. We see small caps underperforming quite slightly. We see value underperforming a little bit. Does that mean we should suddenly abandon diversification and begin chasing whatever the hot stock of the moment is? Absolutely not. Doug, that’s greed-fear cycle. The whole idea behind diversification is to help smooth that out. Definitely, definitely support diversification.

I’m going to walk you through three principles that really drive how we think about fixed income at Mercer Advisors. For the sake of brevity, for the sake of time, I obviously can’t do a college course on fixed income investing, so we’re going to try to keep it a fairly high level, but we certainly invite your questions.

First and foremost, we use bonds to reduce risk. It’s amazing to me how many folks come to me, and say, “Well, Don, I want a higher return.” When I think about it, the reality is they don’t want a higher return. What they really want to do is they want to maximize their wealth, which I think is natural. That’s why we’re chasing higher returns. We all want to have more wealth to spend, to support our financial goals, to leave to our family, to our loved ones.

What I want to draw your attention to on this particular screen is really the ending wealth. That’s how we’re going to measure success here. What we’re looking at right here is the average return, let’s say, for an individual stock, but we’re also looking at the risk. I made a claim earlier and I’m about to prove it here mathematically. The risk is just as or even more important than to return you on when it comes to maximizing your future wealth.

Here we are. We have a stock that’s had a 10% return with 30% risk, and you’ll see that it’s up, its down, it’s up, it’s down, and this is just a randomized projection, so I don’t want you to fixate too much on these numbers in the middle. But mathematically, at the end of 20 years, this particular stock with that much risk and that much return would give you 3.1 million in ending wealth. Fair enough. Pretty straightforward.

Now in theory, let’s just assume somewhere on planet Earth, we could find a CD fully guaranteed, no risk, paying 10% per year. Now, newsflash, this does not exist anywhere on planet Earth. This is purely just an example because I want to prove a point that you can have two investments with the same exact return, same exact return, but different levels of risk. One has a whole bunch of risk, one theoretically has no risk, and you end up with significantly more wealth at the end of that 20-year period. Now, they both earned mathematically the same exact return, same exact return, but the one on the right had zero risk. The takeaway from that exercise should be that, “Huh, it’d be great if we could control risk, if we could reduce risk.” That’s the message.

Now, let’s just take it a few steps further, all right? Let’s look real world. Now, when we look at the US stock market collectively, meaning, the whole asset class, that has a return expectation of about 8%, and it has about 15% risk. Now, we can see here that if we had a diversified stock portfolio, that at the end of 20 years, mathematically, that portfolio generates $3.8 million in wealth. Interesting. Here, we have a strategy with a lower return than the first one. By 2%, that generated more wealth than the first one. I claim that mathematically, I can have a lower return than somebody else, and yet if I have better risk management, I’m going to generate more wealth for my client. That’s not an opinion. That’s just math, all right?

Now, let’s take it one step further. This is our diversified 60/40, meaning, 60% stock, multifactor. We talked about factors a few moments ago, 60% stocks, 40% bonds. Mathematically, that portfolio has an expected return of about 6% with about 8% risk level. If we just look at what that has done and what it can do over the next 20 years, it’s going to generate 3.1 million in wealth, which interestingly, is slightly more than this first investment that had a return significantly higher than the 6%, and the less risky portfolio, the 60/40, created more wealth.

This is why we use bonds. We are helping our clients solve for maximizing their future wealth. It’s not just about the return. Oftentimes, Doug, when we’re trying to convince investors to diversify to own bonds, that’s where we get that push back. The bonds are paying 3%. I want to own something else that has maybe historically earned much more. This is why we own bonds, to reduce risk, and reducing risk does not necessarily sacrifice future wealth. In fact, quite the opposite, it’s going to help you capture future wealth.

Point number two, because we are focused on using bonds to reduce risk in our portfolios, we focus only on owning high-quality investment grade bonds. By the way, let me just caveat that for a moment. We focus on owning high-quality bonds in our core strategies. To be fair, there are oftentimes where an advisor and a client for a given special reason will own different kinds of bonds because they’re trying to solve a different financial problem. But by and large, we focus on very high-quality bonds.

The way to read this particular slide is over here on the up and down, this is the return, this is the yield, and from left to right is the correlation of the bonds to the stock markets. When we own bonds, we don’t want them to give us bond-like returns with stock-like risk. That doesn’t make any sense. Why would you earn bond-like returns, yet have all the risk that’s inherent in the stock market?

That’s why you’re going to find that generally speaking, we don’t own high-yield bonds. We’re convertibles. We’re emerging market bonds. Generally speaking, we don’t want to own that stuff because of the risk. I would argue that anything pretty much to the right of this line, we really don’t want to own because we already have stocks in our portfolio. The idea is not to have more stock-like risk in the portfolio.

We like to stay down this end of the chart. We like high quality. What do I mean by quality? I mean companies and countries that have really high credit scores. I don’t want to be lending your retirement savings to somebody with a 500 credit score. I want to lend it to the folks that have a 750 credit score and above because I know that they’re going to repay me. I’m not worried about the US federal government repaying us our money when we buy US Treasury bonds. I’m not worried about Germany, or Japan, or anyone like that. We try to stay down here. Again, if we stay down here, we actually reduce the risk in our portfolio. Again, remember, that’s why we own bonds, all right?

What’s the next principle? I would say the final principle that we’ll touch on today is we stick with short-term bonds. If you think about it, longer-term bonds, sure, they pay a higher interest rate. If you go to the bank and you’re going to take a 30-year mortgage out, you’re going to pay a higher interest rate than if you take a 15, all right? Now, the reason we stick with short-term bonds is precisely because short-term bonds are less sensitive to interest rates. What we’re trying to do is we’re trying to hedge interest rate risk out of your portfolio.

What we’re just demonstrating here is with a 1% rise in interest rates, you can see that your two-year US Treasury bill would actually decline in value by about 0.1%. You want to focus on the greenish bar here because that would be your total return. Five-year bonds, you would lose 2.8% of your bond portfolio if interest rates went up. As you can see, as we go out longer in time, that that green bar gets bigger, and bigger, and bigger. For 30-year bonds, just a 1% rise in rates, you’re going to lose 15% of your bond value in your portfolio.

We want to own short-term bonds in our portfolio. One of the reasons why…another reason why, I just want to highlight why we want these high-quality bonds, is they are more liquid. What you see here in this bottom left-hand chart is that these high-yield bonds, or emerging market bonds, or Euro high-yield bonds, they tend to be very illiquid, and that hurts you when you’re selling bonds. Maybe you’re trying to rebalance the portfolio. Maybe you’re trying to make a withdrawal to pay for your kid’s college. That’s why you want to own very high-quality bonds in your portfolio. They’re very, very liquid.

Doug, that’s our final point here that I wanted to touch on today, given our time constraint. I hope that our audience found some value in that.



Well, let’s talk about, Don, where we stand just relative to how we’re going about looking at the markets right now. Just recapping, strong year-to-date returns, economies in good shape, and we went into great detail about how we go about managing money in the bond market. Just recap for our audience what they should be thinking about as we’re going through the course of the summer, and of course, we’re going to continue to do these webinars on a quarterly basis.



Yeah. At the end of the day, the advice still stands. Our investors should remain globally diversified across multiple asset classes. They should stay diversified within those asset classes. If they do that, Doug, they’re going to be just fine. It’s amazing. In the fourth quarter of last year, we had a lot of clients questioning, “Hey, why do we still own stocks?” Earlier last year, people are asking, “Why do I want to own bonds? It’s a rising interest rate environment, Don. I don’t know if I want to own bonds.” Then boom, fourth quarter hits, suddenly, everybody wanted to own more bonds. Diversification works. We want to stick with that.

In terms of just some closing comments here, Doug, and then maybe we’ll open up for some questions, is I think the first takeaway for our investors is year-to-date returns in stocks and bonds have been really strong. It’s a good year. It’s a really good year. Let’s take it while we have it, all right? Number two, equity markets are not overvalued. They’re pretty much in line with their long-term historical average, so try to avoid all the noise that’s claiming that equity markets are overvalued somehow.

The US economy continues to grow. Outside of the US, the global economy continues to grow. The emerging markets have very healthy growth, just under 5%. The US consumer, the engine of the US economy is in great shape from what we’re seeing with respect to, again, how we think about bonds. Bonds are used to reduce portfolio risk, which helps build your wealth over time.

Number six here would be to reduce risk. We want to own high-quality bonds. We don’t want to own the junk bonds in the marketplace. We don’t want to own bonds issued by the government of Greece or Venezuela. We want to own the high-quality bonds. Then finally, to hedge against interest rate risk, short-term bonds are better than those long-term bonds. That’s a very fundamental level. That’s how we think about investing in fixed income.



Ladies and gentlemen, this is a great time for you to send us a question. You can use that function in the toolbar. Type in a question to us. We’re going to go through the Q&A portion of the presentation for the next 18, 19 minutes, and answer as many questions as we can.

Don, let’s jump into the Q&A. We have a question right here. “A lot of investors have talked to us about this, but there’s big concern about the national debt. The deficits are continuing to rise. How may the national debt affect the stock and bond markets going forward?”



Yeah. I think all of us should, in just my personal view, should be concerned about the rise in the national debt. Currently, the US government is $22 trillion in debt, and that’s increasing by about $1 trillion a year at the moment. I think it’s a real challenge. If you really think about it, where we could run into trouble is if the Congress fails to increase the debt ceiling. Now, right now, it sounds like they’ve come to an agreement. They’ve punted until after the next presidential election for the most part. But that’s usually where markets start to get really concerned is when we have this dysfunction in Washington.

In theory, technically, the US government could default on its debt if they fail to increase that debt ceiling. We’ve seen in the past where stock markets become quite volatile when the Congress and the White House cannot come to an agreement. I think that that’s going to increasingly become a front burner political issue for this country, and we obviously have two parties that think very differently about that, and whether or not we should increase our debt limits. Long term, there are many academics who argue that we shouldn’t be as concerned about it because of the strength of the US dollar. I don’t share that view. Even though I’m not an academic, I still think it’s critically important that as a country, we get our financial affairs in order.



It’s something that we’re monitoring going forward. There’s no immediate concern. We’re not seeing any volatility interest rates. We’re not seeing a big drop in the US dollar and so it’s something that we are certainly paying attention to relative to the future.






There’s significant talk in the news again recently about indications of a recession. Can Don share his thoughts on how the investment team is looking at that issue?



Yeah. We closely follow economic data. To be fair, we’ve been talking about the next recession since the last one. Since March of ’09, we’ve been talking about the next recession, the next market correction. Look, the reality is last year, many economists were predicting that we would be in a recession by this time this year. We’re not. Like I said, the economy continues to do well. To be fair, economic growth did slow down. Last year, earlier last year, USC economic growth was coming in at around 4% annually, so we have seen that economic growth slowed down. But we are a far cry from a recession at this point.

I’m just not seeing it in the data. That’s why I look at the US consumer. As long as the US consumer has a job, their wages are going up, they’re feeling good about their balance sheet, they’re going to go to on prime day and they’re going to buy stuff. I don’t see a recession in the near future. To be fair, I can’t predict these things any better than the next person. But again, we just look at the data. I just don’t see it at the moment.

Now, what could jeopardize that, to be fair, would be, in just my personal view, would be if the US and China fail to come to an agreement on trade. I think that those are real concerns. The biggest threat to the current economic expansion would be the trade wars between the United States and China. But also, the trade frictions that the United States has with many of our closest allies, the European Union, Canada, Mexico. There’s certainly a lot of trade friction there, so that gives me some pause, and I’m not saying that there aren’t real issues there that need to be tackled, but if we don’t come to an agreement, that could really hurt our economy.



I have a number of questions in the queue that are asking about Brexit, and what’s going on in Europe, and that Europe is slowing down. Comment on, first, our global diversification, and then let’s swing back to the issue of some of the news that’s out there relative to what’s going on across the pond.



Sure. Our typical equity portfolio owns equities in about 40 to 45 different countries, just depending on the portfolio. We’re globally diversified. Obviously, we own stocks in the United Kingdom, we own European stocks, but we also own many Asian country stocks, Latin American stocks. We’re globally diversified. I would argue that that diversification is the best way to deal with these geopolitical events that are just so hard to predict.

Obviously, Britain has voted in June of 2016 to exit the European Union. That has been a very bumpy experience, obviously. I personally don’t think it’s a good idea for the United Kingdom to exit the European Union. Not to delegitimize the concerns that UK citizens have around the EU, I think there’s some legitimate concerns there. But it would be my preference that they would stay in the European Union.

I do think that that’s going to hurt the British economy. I do think it’ll hurt the British pound relative to other currencies. But here’s the reality at this point. We’ve known about Brexit for three years, which means markets have largely priced this in. That’s what markets do, they price in this information, Doug, in real time. It’s no longer news. It’s not new news. It’s really, really old news at this point. I’m not sure that it’s going to derail markets in any serious way. Even when they voted for Brexit, if people remember back to June of ’16, we saw the market selloff pretty significantly. Then within a week, it bounced right back. The market said, “Okay. Whatever. It just moved. It moved on.”



Don, it’s an opportunity for us to just talk about the news cycle and the media itself. People have to realize that newspapers, websites around the world have a lot of real estate to feel each and every day with articles about whatever. Many times, there are stories that are extended, stretched, talked about over, and over again, and the issue of Brexit, the issue of China, all those things are going to continue to be in the news. But when you look at how the markets had performed so far this year, if you were listening, and reading your newspaper, and making your investment decisions through that lens, you might have been sitting 100% in cash all year long and missed out on the 20% gain in the stock market. People have to realize that newspapers have a job to do, but it is not to help our clients manage their portfolios.



So true, Doug. I have a screenshot from late December. Let’s rewind the tape. December 24th last year, the market hit the bottom. Christmas Day, I’m sitting there reading CNBC and I had two storylines right next to each other. One said, “Experts predict 20% decline in stocks in 2019.” Literally right next to it, another story that said, “Experts predict 20% increase in stocks in 2019.” It’s just amazing to me how you’re so right. Their job is to fill real estate, capture eyeballs.

From day to day, there’s actually very little “new news”, but oftentimes, a journalist will grab a nugget, and then from there, engage in a bunch of forecasting or hypotheticals. If you read most news articles today, most of them are hypotheticals. Very few of them actually have any real data in them.



Don, the questions are coming through here regarding the bond market and risk management. Can you talk a little bit about asset allocation and our advisors…our advisors are the closest to our clients, and how we go about managing risk? We look at risk in one’s portfolio.



There’s a lot of different kinds of risks that threaten your financial freedom, your economic freedom. I would say the most important risk is actually our own behavior. Working closely with an advisor, building a financial plan, meeting with that advisor regularly to update that plan to make sure it’s on track, to get your advisor’s perspective on what’s happening in markets, that is key to managing our behavior. We showed a slide earlier, Doug, where that bad behavior penalty is 5% annually. That’s a big number.

Number one, I think you have to manage that risk. Now, let’s talk about market risks and get a bit more quantitative. When we think about global risks and we look across all the different asset classes, stocks, bonds, real estate, commodities, oil, precious metals, currencies, the whole nine yards, the best way to handle the fluctuations, which are very random, and all of these asset classes is to diversify. Now, your advisor knows you best and your advisor knows all of the tools that we have in our arsenal to help you with your portfolio.

Working closely with your advisor, that’s how you’re ultimately going to determine the optimal asset allocation given your situation. A lot of folks come to us, and say, “Don, how should I be invested given the global markets?” I would say to that, “I don’t know how to answer that. I need more information.” That is really a function of your balance sheet and how much balance sheet risk can you and your family absorb.

Somebody with $10 million who spends only 200,000 a year, that person could probably own 100% stocks and be just fine because they could live off of the dividend yield quite easily. But if you have somebody that has, say, 5 million and spending 200,000 a year, that’s a 4% distribution rate. I would argue that’s harder to sustain, owning 100% stocks. There’s a lot that goes into that asset allocation question. More than just what’s happening in markets, obviously, that’s an important input, but so as your inflation assumptions, and spending, and your tax rates, and so on, and so forth.



Well, one of the things that we wanted people to take away from today’s program was understanding that your fixed income allocation plays an important part in managing your assets and managing your behavior because, well, look at the performance of the market year today up 20%. If you were 100% stocks, you would enjoy that gain. But when we get into the next market correction, you wouldn’t be able to handle the volatility. The volatility would most likely cause many people to want to jump in, and take control, and do something.



Yeah. No, absolutely. Doug, this is why we rebalance our portfolio systematically. Let’s just rewind the tape to the fourth quarter of last year. Early November, we were selling bonds and buying stocks because that was the right thing to do. If you have a given allocation, let’s say 50/50, in the fourth quarter of last year, you weren’t 50/50 anymore. Your portfolio, the stock part had declined, so we were selling bonds, buying stocks.

Now, we’re not clairvoyant. We weren’t trying to predict the future. We’re just trying to keep your portfolio on track for your personal financial plan. Now, let’s fast forward to today. What are we doing? I’m going to tell you right now. We’re selling stocks and we’re buying bonds. We’re rebalancing. The stocks have recovered handsomely. We have great return so far year-to-date. It’s time to sell some stocks and buy bonds. The great thing is we’re doing that for our clients already. They don’t have to call us. We’re doing it already. It’s just part of our system. Talk to your advisor if you have questions about rebalancing, how are we doing it for them in their accounts. Please reach out to your advisors.



We have a question in the queue from a client who’s asking about the impact of the next election, the presidential election on the stock market. I wanted to come back to a question that we received from a client a year ago. They were asking the question, “Specifically, if democrats take over the house in the midterm election, will the stock market slide lower?” Talk to us about politics and markets.



Newsflash, the Democrats did win, and take over the House in November, and markets have been just fine. In fact, they’ve been more than fine. We’ve had a great year. When President Trump was elected in November of 2016, the market took off. He’s a Republican. Democrats took over the House last November. In both instances, markets have done well. There really isn’t any evidence that shows that one political party by itself is better for the markets or the economy. It’s very noisy data.

I know that in today’s society where we’re so divided, we all want to believe that our political party or our particular candidate has found the Holy Grail. They have the key, the secret sauce for economic growth, and I just don’t buy that. I don’t see it in the data. As all of you know, I’m very data-driven. I just don’t see any math that suggests that we should be concerned about one political party controlling the House, the Senate, or the White House.

If anything the data does hint, hint, that the economy does better when we have divided government, meaning, one party controls the White House, and one controls one or both chambers of the Congress. It seems that the markets like it when there’s a little bit of paralysis in Washington. I hope that answers that question.



Don, come back and let’s talk a little bit more about some of the things that will keep you up at night. We have the issue of trade wars, and tariffs, and what’s going on in Europe, but talk about how you go about looking at markets, you’re coaching advisors, you’re directing the investment committee. How do we go about this here at Mercer Advisors?



The things that keep me up at night right now are my daughter. In the economic realm, the things that, I think, keep me up at night that, I think, we as an Investment Committee need to stay focused on are really bigger macro trends. One of the things that concerns me the most is what I consider to be this breakdown in honest discourse in our country, and globally. It’s very hard for us to have differences of opinion these days without making the other side out to be the enemy or evil, and that concerns me because as a society, we thrive on differences of opinion. That’s how modern capitalism has pulled us into the 21st century, so that concerns me a little bit.

Getting a little bit more granular, when I think about the economy, what concerns me, and again, this is a broader macro trend, is the state of education in the United States. If the United States is going to be competitive economically with countries like China and India, we really have to improve the state of our educational system in this country. We have the world’s best universities. That’s not where we’re weak. Where we’re weak is that K–12, especially the state of math and science education. Those are areas that if we’re going to have economically productive workers in the future, we really have to get our house in order on that front. Our math scores are appalling relative to other developed nations.

A little bit more short term, I’m concerned about trade wars. I’m concerned that if we don’t get to solve corporate earnings in the next 12 months, we’re really going to begin to suffer, so that’s more of a short-term concern.

In terms of advising our committee and everything else, we obsess over risking our client portfolios, Doug. As you know, we’re not the firm that people hire to go out there and try to beat the market. Our job is to help our clients get to economic freedom and stay economically free. In order to do that, we have to manage those risks. Me, my team, the investment strategy team, the Investment Committee, we focus obsessively on making sure that the portfolios that we put in place for our clients, that we are removing as much unnecessary risk as humanly and as mathematically possible.



Let’s just talk a little bit about inflation. We haven’t touched on it today. Inflation remains relatively low. We actually build into our models a higher future inflation just from a safety perspective and inflation may swing higher at some point in time. But talk about inflation, fixed income, and equities, and how those things work together.



Yeah. So far, inflation right now has been pretty mild. It’s below 2%. The Federal Reserve has a 2% target. That’s where they want inflation to be. Look, the best hedge against inflation from the perspective of a retiree is to own equities long term. It’s not gold. It’s not all this other stuff that we read about in the dark corners of the internet. It’s stocks. Stocks have the highest expected return. If you want to stay on top of inflation long term, you have to own stocks.

Stocks are the inflation hedge in our portfolios. That’s how I look at it. Fixed income is the ballast in the portfolio to help reduce risk. Long-term bond returns are going to be maybe slightly above inflation, maybe a little more, but bonds long term are rarely the asset class that’s going to get you to economic freedom and keep you there in perpetuity.

One more note on inflation, you mentioned that we assume a higher rate of inflation. There’s a reason for that, Doug. Our clients are in their late 50s and early 60s, by and large. It’s an average. If you actually break down inflation across the US demographic, what you see is senior citizens experience a much higher inflation rate than younger people, for example, coming fresh out of college, and that’s because they are the primary consumers of health care services. Look at your health insurance premium. There’s the health insurance inflation. That’s 5%, 6%, 7%, so that’s why we assume those higher average inflation rates when we do our planning.



Don, I think that’s a great spot for us to bring our Q&A section to an end. We want everyone to understand that we will continue to do these webinars on a quarterly basis to keep you up-to-date on what’s going on in the financial markets. We also want you to know that there are some great additional resources out at Under the Insights tab at our website, there are articles, there are podcasts. We will post this webinar out there, so you can listen to this if you came in halfway through. If you have a friend that wasn’t here with us today, we’ll post a recording of this. But the Insights tab is something that is a great place to go to look for additional information on many subjects.

We also want to encourage all of our clients, if a question today wasn’t answered, if you want to revisit something that we discussed today, your best path to doing that is connecting with your advisor. We really want to encourage you to reach out to your advisor, to have a conversation with your advisor, their team, and talk about some of the things that we discussed here on the call today. If there are any changes that need to be made to your investment strategy, that would be done in a conversation with your advisor.

Lastly, I want to mention the Science of Economic Freedom podcast. This is another tool that we have for you out at We have over 60 podcasts posted and we have a specific page out there. We have subjects for you to be able to delve more deeply into, and it’s another service that we want to provide, so you stay up-to-date on the financial markets and subjects. We want to remind everyone that the pursuit of economic freedom is a journey. It’s not a destination. When you have achieved the economic freedom, you want to stay there, and we want to provide you with all the resources to be able to do that.

Lastly, we want to talk about some upcoming events. We’ll be doing some additional town hall events across the country. Here are some that are upcoming. Don will be hosting some town halls in Atlanta and Simsbury, Connecticut. In Atlanta in August, in Simsbury in September, and we’re going to continue to do the quarterly webinars. Our next one is scheduled for October 23rd.

Don, any final comments you want to add to this?



No. I just want to thank everybody for their time today. It’s always an immense honor for me to speak to all of you and I want to thank all of you for the trust and confidence that you continue to place in Mercer. We really value our partnership with you on your journey to economic freedom, so thank you again for your time.



Thank you, ladies and gentlemen, and this concludes our broadcast today.



Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate, but is not guaranteed or warranted by Mercer Advisors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.

This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control.

Mercer Advisors is not a law firm and does not provide legal advice to clients. All estate planning documentation preparation and other legal advice is provided through its affiliation with Advanced Services Law Group, Inc.

This document is a transcription. While it is believed to be current and accurate, it is not warranted to be so. Should any inaccuracies or omissions be found, please notify for correction. Divergence from the original in format and pagination are to be expected.

The information provided in this presentation is intended to educate and is for information purposes only. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an Investment Adviser with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate, but is not guaranteed or warranted by Mercer Advisors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. This presentation is not a substitute for a client-specific suitability analysis conducted by you and your advisors. You and your advisor must determine the suitability of a particular investment based on the characteristics and features of the investment and relevant information provided by you, including, but not limited to, your existing portfolio, investment objectives, risk profile, and liquidity needs. Investments mentioned in this document may not be suitable for all investors. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.Investments are subject to market risk, including the possible loss of the money you invest. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. This document may contain forward looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control. Mercer Advisors is not a law firm and does not provide legal advice to clients. All estate planning documentation preparation and other legal advice is provided through its affiliation with Advanced Services Law Group, Inc. The content is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.

View the Full Transcript

Talk with a Local Advisor

Related Topics:

Talk to Us.