Special Investment Update – August 15, 2017

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Dear Clients and Friends,
As we stressed in the past, risks are mounting for Wall Street’s long-running and rapidly aging bull. Our defensive strategy does not require us to sell all of our stocks – far from it. In fact, we have continued to buy dividend-rich securities for projected returns in excess of 10%. However, we have and will continue to exercise caution in our investments. So, how do we protect our portfolios from painful, disruptive change?  As we previously discussed, with the eight-year U.S. business expansion growing long in the tooth, there is a good chance the financial markets will experience a more than trivial “disruption” sometime in 2018, perhaps even sooner. This special update focuses on how we have been able to harden our defenses against unpleasant market surprises. The goal is not to avoid risk entirely, which is impossible. Rather, we want to take intelligent measures to reduce unnecessary risk.

Futurists and gadget lovers make a big deal about the disruptive power of technology. They are right too. Inventions such as the personal computer, the cellphone, and above all, the Internet have transformed the lives of people everywhere in recent decades. And there is more coming. Biotech is conquering diseases that had long resisted other cures. Electric and self-driving cars will profoundly alter the way we travel and the amount of fossil fuel we consume. Solar power threatens to turn the economics of the utility industry upside down in places where homeowners can generate enough electricity from the sun to become net suppliers to the grid. As investors, we need to be aware of these trends, and to remain flexible.

Besides technological change, there is another type of disruptive change that can hurt investors. We are talking about “market shocks”. In recent years, the Federal Reserve, along with other central banks around the globe have provided a security blanket for stock market investors. Near-zero interest rates and wave after wave of “quantitative easing” have muffled the impact of economic and political events that might otherwise have sparked another financial crisis. However, the Federal Reserve is now slowly withdrawing the security blanket, at a time when equity valuations have climbed quite high by historical standards. While we do not expect a severe market disruption in 2017, the risk of an accident is no longer negligible and it is steadily rising.

As we have previously discussed, we have been re-positioning our portfolios to reflect for the changing environment. One of the first steps was to change our overall asset allocation of Equity, Fixed Income and Cash. We basically reduced our Equity and Fixed Income allocation by up to 5% each and increased our cash position by up to 10%. Thus, our current average allocation mix remain at 40-50% Equity, 40-50% Fixed Income and 0-20% in cash for most of our portfolios.  In addition, we analyzed all of our industries in our portfolios for proper diversification. If certain industries such as technology were over weighted in certain portfolios, we trimmed those positions to the proper percentage of our equity holdings. Furthermore, we shifted many of our equity holdings to dividend-rich securities to build a significantly higher degree of safety into our portfolios.

There are some on Wall Street who are starting to feel that stocks are not going to pull back meaningfully anytime in the near future. Instead, the market is about to launch into a near-vertical “melt-up”. The more moderate promoters of this theory, such as Dr. Ed Yardeni, say that an ongoing surge in corporate profits could lift the Standard & Poor’s 500 Index another 8% by the middle of next year, to the 2,600-2,700 range. So, while we are still inclined to sell stocks and sectors that have overshot any reasonable valuation bounds, we are also willing to invest in companies that offer the prospect of achieving at least a 10% total return over the next year.

For the last several weeks, the stock market has tempted fate by creeping higher and higher without undergoing a normal pullback. Then came the latest confrontation between the United States and North Korea. We do not have any special insight into how this geopolitical flare-up will end. However, we strongly feel that, the headline U.S. equity indexes are overdue for a 5% or greater dip. We also feel that at this stage, there is little or no evidence that suggests the market has formed a major top. Thus, we are proceeding on the assumption that as long as our roadmap calls for eventual new highs, we will continue with our strategy.

We want to thank all of you for giving our firm the opportunity to serve you. We thank you very much for the trust and confidence you have placed in our firm as it is always appreciated. Please contact us should you have any questions or comments. Also, we want to invite you to visit our website at www.farmandinvestments.com for a quick Retirement calculator, our latest firm news, and Market Commentary archives.

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