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Q3 2016 Commentary

CENTRAL BANKS VERSUS SYSTEMIC RISKS

The global financial markets took a sharp dive to begin the third quarter in response to the shocking Brexit vote. While there was much hyperbole surrounding the vote, after a few weeks of downside volatility, the U.S. stock market began to recover in mid-July, and by the end of the quarter had entirely erased the Brexit vote losses, finishing in the green.

That’s not to say the Brexit vote won’t have real economic and market implications, rather, those concerns have been pushed to another day. As was expected by the market, the Bank of England cut interest rates in response to the Brexit vote to support financial markets. In this era of the central banker, any exogenous shock will be met with a policy response. Natural market forces simply cannot be trusted, as they may inflict the one thing most politicians and policymakers fear: short-term pain.

As the title to this commentary suggests, there are numerous risks present in the global financial system that central banks are attempting to contain in a constant game of whack-a-mole. From undercapitalized European banks such as Deutsche Bank, Germany’s largest bank, to the Italian banking system, where some estimates of non-performing loans run as high as 350 billion Euros, to the near exponential credit growth in China, to growing political unrest with establishment policies in many parts of the world, central banks have plenty to worry about.

While everyone is aware of the upcoming U.S. presidential election, fewer are talking about an important vote taking place in Europe. In the fourth quarter, the pro-European Union (EU) Italian government of Prime Minister Matteo Renzi is holding a referendum on changing the Italian constitution to limit the powers of the Italian Senate. This vote is effectively a vote of confidence in the current pro-EU government. Prime Minister Renzi has promised to resign if it fails. If that were to occur, the Five Star Movement, which is anti-globalist, anti-euro, and anti-establishment, would likely come to power. To say this could cause some market volatility may be an understatement. And yet, most investors are fairly complacent about these risks. Not because they aren’t aware of them but because they have been conditioned to believe that central banks will act decisively to thwart any lasting negative market consequences.

STRATEGY

While we believe the blind faith in the near omnipotence of central banks to control market forces will be sorely disabused in the future, the timing of when is unknowable. If central banks have the will to act and enough credit is created to buy all manner of assets including government and corporate bonds, real estate investment trusts, and even stocks, as the Bank of Japan and the Swiss National Bank have done, this era of monetary hyper-activism could continue for a while. In the interim, in this yield-starved world, we continue to favor a diversified portfolio comprised of companies with durable and competitive market positions, intermediate bonds, real estate, precious metals, and cash. While it is true cash pays you next to nothing, its appeal comes from its lack of correlation with other portfolio holdings and the optionality it provides to purchase great businesses on market weakness.

As always, we appreciate the trust you place in us as we remain diligent in helping you to achieve your financial objectives.

Source: ishares, spdrs

FINANCIAL PLANNING FOCUS

Do your life insurance beneficiaries align with your estate planning? Does your CPA know of the extra income coming your way from an inherited account? If the answer would be “no” to these and/or many other questions, the impact can be far-reaching. Professional coordination is a good example of a non-obvious benefit of financial planning—a benefit that can at times be one of the most fruitful. It’s normal for us not to realize how complex our financial lives are, therefore we don’t recognize the importance of coordination between the different parts, or we realize the importance when it’s too late. You may have a great insurance agent, an experienced attorney, a top-notch CPA and a trusted investment advisor who serve you well; but, if those professionals don’t interface, to use the old phrase, “the left hand doesn’t know what the right hand is doing.” Having collaboration between your professional advisors will without question serve you well. But keeping the communication lines open requires time and effort. Many of our clients prefer to outsource that to us rather than add it to their “to do” list.

Coordinating among our clients’ professional advisors is one of the services we offer through our financial planning engagements. But, in order to do it well, we must first have a full understanding of our clients’ financial affairs—not just numbers, but their personal values and aspirations as well. Our financial planning engagements are designed to create a framework for this type of collaboration. While requiring a commitment of time and resources on the front end from client and advisor, the fruit of the labor is seen quickly and can have a significant impact.

If you would like to learn more about our financial planning services, visit our Financial Planning page or contact Melissa Ballard at 865.693.6301 or mballard@pyawaltman.com.

 

The information contained in this commentary has been provided by PYA Waltman Capital, LLC for general information purposes only and has been obtained from sources believed to be reliable, but is not guaranteed. The information shall not constitute investment advice or an offer or recommendation to buy or sell any security, commodity or services. The products and services described in this commentary may not be available to, or suitable for, all investors.

Past performance does not guarantee future results. Market conditions can vary widely over time and can result in a loss of portfolio value.