Cheap stocks outperform expensive stocks.  It is a well-documented investment anomaly.  Investors are compensated for owning stocks by not only earning the return of the market, but an additional “value premium.”  It exists over the long-term, but does not work every quarter or every year.  Companies possessing value characteristics such as a low Price to Earnings Ratio are put into the value “style” (as opposed to the growth style).

Why own small companies classified as ‘value’ versus small growth companies?  Over the last 36 years in the United States, the small value index outperformed by nearly three times.  Large value stocks outperformed large growth stocks by 42% over this period.

Is this just a U.S. abnormality?  Looking at international markets, the answer is definitely ‘No.’ In fact, the exact same ranking order for size and style as in the U.S. was evident for as long as we have data, which is back to 1994.  Both went from Small Value, to Large Value, to Large Growth, to Small Growth.

Over the same time frame, companies in the emerging markets based on size (large, small) and style (value, growth) ranked in the same order as the international developed market peers.  It is clear the value premium exists in addition to a small cap premium (which we will leave for another time).

Yet, this does not hold for the last five years across regions.  In fact, the worst performing style (small growth) over the multi-decade periods we looked at performed the best in each region.

Note that growth outperformed value across both large cap and small caps in the U.S., Internationally, and Emerging Markets (EM).

One reason for the difference in style performance the last five years is sector dispersion.  With biotechnology and pharmaceutical companies reaping the benefit of years of research and development costs on building a pipeline of drugs, the healthcare sector shot through the roof.  The American consumer continues to shop and go out to eat, boosting share prices for the discretionary sector. Technology is on fire from all the fundraising in Silicon Valley (a sign of excess perhaps with an HBO show called “Silicon Valley”) and growth from Facebook, Google, Apple, et al.

Looking under the hood of the small cap style indices shows a big difference in weights in these three top performing sectors over the past five years.

In total, the U.S. small growth index has nearly 3 times as much sector exposure to healthcare, consumer discretionary, and technology as the U.S. small value index.  For today, the growth ‘style’ is in and value is out, with sector exposure being the main driver of the difference.

The “momentum premium” typically rules in the short-term, with assets outperforming on a relative basis persisting with outperformance anywhere from 2-12 months into the future.  We highly doubt that cheap stocks will underperform expensive stocks in the long-term, however, cyclical periods of growth outperformance occurred in the past and likely will again.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Remember when everyone said the U.S. dollar was going to collapse because of quantitative easing?  In fact, the opposite happened.  The dollar is too strong (up 40% in the last four years), especially for countries that peg its currency to ours.  To compete with Japan’s falling yen and bump up its own exports, China needs its own currency (the Yuan, aka Renminbi or RMB) to be weaker.

We have regular conversations with the ‘boots on the ground’ in foreign countries and subscriptions to millions of data series that tie together the qualitative story abroad with the quantitative.

Ashmore, a large global asset manager, penned a nice note on the currency moves in China.  Jan Dehn wrote, “Closing the gap between the fixing and market based valuations of the Renminbi (RMB) is one of the key requirements for SDR (Special Drawing Rights) inclusion [the International Monetary Fund recommends inclusion as a ‘usable’ currency].  This action therefore takes China one step closer to SDR inclusion – set formally to happen this year with practical implementation starting around the time of the G20 summit to be held in November 2016 (where Obama will give his nod of approval as a final gesture before leaving office).  SDR inclusion in turn is part of a much broader set of reforms.”
Ashmore’s note continues, “Remember why China is implementing reforms, including liberalizing its currency regime.  The entire purpose of the reforms is to prepare the economy for Renminbi appreciation, i.e. a rise in the Yuan once QE (Quantitative Easing) across the Western world creates inflation and currency weakness in the QE countries.  Inflation is likely to begin in late 2016 in the U.S. as the drags on consumers’ willingness to respond to plentiful and cheap liquidity form household deleveraging, negative housing equity, and unemployment ease.”

While we are yet to see the inflation data domestically, there is no denying the healing of household balance sheets and confidence in the U.S.  Consumer credit grew 7% in the second quarter, the fastest pace in a year.  Foreclosures and delinquent mortgages hit the lowest levels since 2007.  Our data measure for retail and food sales adjusted for both population and inflation grew at 2.6% year-over-year in July, which historically correlates to normal growth.

Turning back to China, what has garnered so much attention the last few months is the epic rise and fall of the Shanghai Stock Index.  However, this really is not the stock market to be watching if one is a foreigner invested in Chinese companies.  The A-Shares that trade on the Shanghai exchange just opened up to non-residents in November 2014, with very strict trading limits.  Thus, most investors not based in China are in H-shares, which trade on the Hong Kong Stock Exchange.

The chart below shows the difference of performance over the past year.  The A-share is the market that crashed (yet still up nearly 100% from a year ago), while the H-shares rose and sold off more gradually the last several months.

Today valuation of H-shares are the cheapest since 2003 against the A-Shares.  The MSCI China Index (made up of H-shares) trades at a 10.6 times price to earnings (P/E) ratio and a 2.9% dividend yield.  This compares to the MSCI China A-Share Index trading at a 20 times P/E ratio and a 1.5% dividend yield.
In terms of growth, the electricity and power data do not corroborate the official Chinese statistics of 7% real GDP growth.  These non-official statistics reflect much slower growth, more on par with what China expert economist and professor Michael Pettis put at a 3% long-term and terminal growth rate.  It will be a process as growth rebalances from investment to consumption driven, with many structural changes needed.  Lower growth does not necessarily mean financial assets will perform poorly (the bond market is growing and offering attractive yields, which does not get much airplay).  Numerous studies show there is a zero correlation between economic growth and stock market performance.  This can be attributed to investors anticipating massive growth and chasing the markets higher, only to, on average, be disappointed by the subsequent data.

This excitement phase happened in the mid 2000’s and peaked in 2010; the last few years were disappointing, with fair values finally being served up to investors.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Stock options and grants are commonly used to compensate and incent employees without requiring any
cash outlay. This allows the employees to share in the appreciation of a business while also allowing the
company to compensate its employees without needing cash on hand (which can be a significant benefit
for early-stage companies that may be cash-poor). When drafting stock option and grant agreements, it
is important that attorneys keep in mind the VALUATION considerations related to both the value of the
underlying stock and any related stock options, which are critical for accounting and tax purposes.

What Are Stock Options and Grants?

While they may sound similar, stock options and stock grants are actually two different equity instruments:

• Stock Options – Represent the right, but not the obligation, to purchase an ownership interest in a
  company at a specific price over a defined time period (e.g. the right to buy one share of Apple for
  $100.00 at any time during a three-year period).
• Stock Grants – Represents the issuance of an actual share of stock. Unlike a stock option, which
  requires a cash outlay to exercise the option, no purchase or cash outlay is necessary when a stock
  grant is made – the recipient simply becomes the owner of the shares granted.

Valuing Stock Options and Grants 

• There are certain differences in the valuation of stock options vs. stock grants:
  Stock Options – The value must be determined using an option valuation model, such as the
  widely-used Black-Scholes model or a binomial/lattice model (which is not as common in practice,
  but offers more versatility in valuation inputs). The value of the company’s shares must also be determined
  to value any options issued since one of the inputs in valuing an option is the value of the
  underlying shares on the grant date.

• In applying the Black-Scholes model, the following six inputs are required:
  • Fair market value of the underlying stock
  • Exercise price of the option
  • Option term
  • Stock volatility
  • Risk-free rate of return
  • Dividend rate

Therefore, the valuation of a stock option is a two-step process. First, the fair market value of the stock must be determined. Only then can the stock option be valued using an option pricing model.

• Stock Grants – The value is equal to the underlying stock value on the grant date. This sounds
  simple, but can be difficult for privately held companies without the assistance of a third-party valuation
  expert.

Stock Option and Grant Accounting Issues

The accounting for equity-based compensation is complex and the inclusion or exclusion of certain phrases can materially impact how the transactions must be recorded. Generally Accepted Accounting Principles (GAAP) require that the “fair value” of stock options and grants as of the grant date be recorded as an expense of the issuer over the related vesting period (based ASC 718 – Stock-Based Compensation).

It should be noted that even though an option may not be “in the money” on the grant date, it will likely still have value when analyzed using a Black-Scholes model because of the possibility that it may be “in the money” at some point prior to its expiration. Therefore, a company’s auditors will likely require a valuation analysis to support the value of both 1) the company’s underlying shares (for any stock grants issued and as an input to value any stock options); and 2) any stock options issued. These valuation requirements create a hidden cash cost for this “cashless” form of  compensation for privately held companies. Therefore, it is important that the company be aware of these additional compliance requirements before deciding to issue stock options or grants.

Continue reading about stock options and grants by downloading our free e-book: Drafting Considerations for Attorneys. 

To learn more about how a business is valued or to gain insight on the financial and economic issues that affect today’s business world, call the experts in the Valuation and Litigation Support group at 440-449-6800. Please email Sean Saari if you would like to learn more about buy-sell valuation considerations.

There are significant differences in the taxability of stock grants vs. stock options:

• Stock Grants – Stock grants are taxable to the recipient and deductible by the employer when there is no longer a substantial risk of forfeiture (i.e., upon vesting). The employee recognizes ordinary income based on the value of the stock received as of the vesting date.

The recipients of stock grants often consider whether an 83(b) election should be made, which allows the recipient to report as ordinary income the value of the stock received on the grant date rather than the vesting date.  Although this accelerates the recognition of income, it allows for a larger portion of the company’s appreciation to be taxed as capital gains rather than ordinary income (assuming the company appreciates in value over time).

However, there are significant risks  associated with making an 83(b) election.  If a company’s value declines between the grant date and the vesting date the recipient will have recognized a greater amount of ordinary income (and paid the related tax) than the actual value of the stock as of the vesting date.  An even more onerous issue arises if the recipient makes an 83(b) election and then does not ultimately vest in the shares of stock granted (e.g., if the employee quits or is terminated prior to the shares vesting).  In that case, the recipient ends up recognizing ordinary income (and paying the related tax) on the value of stock that he or she never actually received and no related loss deduction is available to offset the accelerated income recognition.

• Stock Options – There are two types of stock options for tax purposes – Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NQSOs). Generally, ISOs offer superior tax benefits to employees, but are not as tax-beneficial to employers and have more issuance restrictions than NQSOs.

Ensuring compliance with IRS Section 409A (“409A”) is even more important than deciding between the issuance of ISOs or NQSOs Section 409A precludes the issuance of options with a strike price/exercise price less than the fair market value of the underlying stock on the grant date.  This is the most significant risk associated with stock options from a tax perspective.  Any deferred compensation (the spread between the exercise price and the fair market value of the stock) under 409A would be taxable to the recipient at ordinary income rates plus a 20% penalty and interest.

Employers could also be liable for penalties associated with under withholding payroll taxes on the deferred compensation amount.  Given the significant tax consequences associated with non-compliance with 409A, it is important that all parties involved with the issuance of stock options for privately-held companies (for which an underlying stock price may not be readily available without a business valuation being performed) are satisfied with the documentation to support the fact that the strike price is equal to or greater than the underlying share value.

The similarities and differences between ISOs and NQSOs are summarized in the chart below:

Stock Options and Grants – Takeaways and Suggestions

The issues surrounding stock options and grants can be complex and impact the issuer and recipient from a number of different standpoints – legal, accounting, tax and valuation.  Therefore, it is important to consider the effects of issuing equity-based compensation from each of these perspectives in order to ensure that the desired outcome is achieved.  A few of the key takeaways and suggestions to keep in mind when drafting stock option and grant agreements are:

• Make sure your clients are aware of the accounting and valuation requirements that are necessary when stock options and grants are issued
• Put procedures in place to ensure that stock options are in compliance with 409A and are not issued with a strike price that is less than the fair market value of the underlying stock on the grant date
• Discuss with your clients and their accountants the tax impact of various equity-based compensation alternatives before granting shares or stock options
• Share draft stock option and grant agreements with the client’s accountant to determine if there are any unexpected accounting or valuation issues that may need to be addressed

Continue reading about the key accounting, tax and valuation considerations of buy-sell agreements in our e-book: Drafting Considerations for Attorneys: Buy-Sell Agreements, Accounting, Tax, and Valuation Issues. Click here to download your free copy.

To learn more about how a business is valued or to gain insight on the financial and economic issues that affect today’s business world, call the experts in the Valuation and Litigation Support group at 440-449-6800. Please email Sean Saari if you would like to learn more about buy-sell valuation considerations.

In many acquisitions, the seller prefers to receive cash in return for the sale of his or her business. This preference stems from the fact that the value of cash is generally accepted and not disputed. After all, “cash is king.” But what happens when, as part of the deal consideration, the buyer offers the acquiring company’s own stock to the seller? While much of the focus in an M&A transaction is on the value of the seller’s business, this issue hinges on the value of the buyer’s business.

As you might expect, estimating the value of the buyer’s stock can be difficult, especially in comparison to the alternative of using cash as consideration for the deal. Stocks are riskier financial instruments than cash, and therefore the value of the buyer’s stock carries far more volatility with it. When the seller is offered stock as consideration in a deal, he or she should consider the marketability characteristics of the stock along with the stock’s valuation fundamentals.

The concept of marketability is critical in ascribing value in these deals. For example, if the buyer’s stock is privately-held, the seller will not be able to quickly liquidate the stock and “unlock” his value. Therefore, when valuing a closely-held interest, valuators apply a lack of marketability discount (oftentimes up to 35% of the company’s equity value) to capture the impact of this lack of marketability on value. This discount takes into account the fact that a minority owner in a privately held company cannot readily turn his or her ownership interest into cash (unlike an investment in a publicly traded company). If this discount is not considered when assigning value to a minority ownership interest in the acquirer’s shares, it can result in the seller receiving less value than he or she would have had all of the proceeds been paid in cash.

On the other hand, if the buyer is a publicly traded company, similar issues can arise. It is common for the buyer in these cases to place restrictions on the sale of stock after the deal closes. For example, restrictions may not permit the sale of shares for periods ranging from a few months to a few years, which make the shares less valuable than they would be if they were freely tradable at the closing of the deal. Once again, the inability for the holder of the stock to sell his shares and monetize his or her interest reduces the value of the stock-based consideration received. In reality, the restricted shares that the seller received are worth less than the published stock price of the acquiring company. Imagine receiving shares of a publicly traded company worth $5 million on the date of issuance and watching them decline to $1 million prior to the restricted sale period elapsing. As a result, it is appropriate to consider a discount for lack of marketability for restricted shares in publicly traded companies. Doing so properly captures the risk associated with potential changes in the price of the acquiring company’s shares before the restricted sale period has ended.

In addition to the marketability concepts discussed above, the seller must take care in understanding the value of the underlying stock. Here are a few questions the seller should consider when determining the value the stock to be received:

• For publicly traded stock, does the current stock price “overvalue” or “undervalue” the stock based on the company’s fundamentals (e.g., earnings results) and comparable companies in its industry?
• What are the earnings expectations of the acquiring company?
• Is the acquiring company healthy from a balance sheet perspective and how will the acquisition of the seller’s company impact the health of the new company post-acquisition?
• How will the acquisition of the seller’s company impact future earnings expectations?
• How will the acquisition of the seller’s company impact the new company’s risk profile after the acquisition is completed?
• In the case of a publicly traded buyer, how will the announcement of the acquisition impact the stock price? Will the stock price get a boost?

As a practical matter, the use of stock as consideration is a mechanism to shift some of the risk of the deal to the seller (much like contingent consideration, such as an earnout). Just because we live in a “buyer beware” world, the seller must also beware and perform due diligence to protect his or her sale price in deals where consideration is made up of something other than cash.

Learn more about the important topics you should be aware of during M&As in our free e-book: Valuation Considerations When Buying or Selling a Business – Part 2. For more information on the various approaches to valuation or our Valuation and Litigation Advisory Services, contact Dan Golish via email or by calling 440-449-6800.

Get caught up on what’s happening in the valuation and litigation advisory profession. We provide links to relevant and interesting news articles that focus on areas that impact our clients; including business valuation, litigation support, economic damages, bankruptcy, divorce matters, and more.

Here’s what’s in valuation news in March:

• Is Your Business Worth As Much As You Think? Many Aren’t
• How Employee Stock Options Work In Startup Companies
• How to Calculate the Implied Value Per Share of Common Equity

For more information about current issues and topics in valuation or our Valuation and Litigation Advisory Services, contact Chris Coyle via email or by calling 440-449-6800.

No doubt you’ve seen headlines reporting that a particular stock index is up or down. But do you know what an index is, and how understanding the nuts and bolts of a specific index may be helpful to you?

An index is simply a way to measure and report the fluctuations of a pool of securities or a representative segment of a market. An index is developed by a company that sets specific criteria to determine which securities are included in the index based on factors such as a company’s size or location, or the liquidity of its stock. For example, the S&P 500 is an index made up of mostly large-cap U.S.-based companies that Standard & Poor’s considers to be leading representatives of a cross-section of industries.

The company that develops the index tracks the performance of its components and aggregates the data to produce a single figure that represents the index as a whole. Virtually every asset class is tracked by at least one index, but because of the size and variety of the stock market, there are more stock indexes than any other type. It’s important to note that the performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index.

Comparing apples to oranges

Since indexes encompass a wide range of securities, it’s important to know what segment of the market a particular index covers. For instance, a composite index follows a specific stock exchange. The Nasdaq Composite Index includes all the stocks listed on the Nasdaq market. Conversely, sector indexes track securities in a specific industry.

Even indexes that include the same securities may not operate in precisely the same way. Generally, indexes tend to be either price-weighted or market capitalization-weighted. If an index is price-weighted, such as the Dow Jones Industrial Average, the impact of each stock on the overall average is proportional to its price compared to other stocks in the index. With a price-weighted index, the highest-priced stocks would have the most impact on the average. For example, a 1 percentage point drop in the price of a stock selling for $80 per share would have more impact on the overall index’s performance than a 1 percentage point drop in the price of a stock that had been selling for $40 a share.

If an index is market capitalization-weighted or market value-weighted, such as the Nasdaq Composite Index or the S&P 500 Composite Index, the average of the index is adjusted to take into account the relative size of each company (its market cap) to reflect its importance to the index. Stocks with a larger market capitalization have a greater influence on how the index performs than stocks with a smaller market capitalization. For example, if the stock of a $10 billion market-cap company drops by 1 percentage point, it will drag down the index’s performance more than a 1 percentage point drop in the share price of a $1 billion market-cap company.

Though an index adheres to a set of guidelines for selection of the securities it includes, the company that oversees the index generally reviews the security selection periodically and may make occasional changes. For example, some indexes may rebalance if an individual security grows so large that it dominates the index. Others have a limit on how much of the index can be devoted to a particular sector or industry, and may rebalance if the proportion gets skewed.

Indexes are worth watching

Stock indexes can provide valuable information for the individual investor. If checked regularly, an index can provide information that may help you stay abreast of how the stock market in general, or a particular segment of it, is faring. However, understanding the differences between indexes and how each one works will help you make better use of the information they provide. All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

Stay up-to-date with the latest business trends, tips and revenue-generating ideas affecting you and your business by subscribing to the Skoda Minotti Blog or by following us on LinkedIn, Twitter @skodaminotti, and Facebook

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Despite the high stock prices and a great run in bond prices, investors can hardly be described as exuberant.  Perhaps it is because they look at the investment landscape and do not see much that they like.

Bond yields fell from 15.75% in 1981 to 1.51% today (see below).

By definition, this yield is the expected return on a risk-free 10-year Treasury bond held to maturity.  It is tough to get excited about these yields as well as meeting financial planning objectives.

It is easy to argue that stocks are priced above fair value.  Price-to-sales, price-to-earnings, price-to-cash flow – all traditional ways to measure relative value – are well above their historical medians.

After looking at these ideas, people are throwing up their hands and asking, “what is the alternative?”

We look at the world a little differently.  The first rule of investing?  Buy low, sell high.  Where have prices been low for a while?  It is emerging markets.

Historically, there are 5 to 7 year cycles where emerging markets and developed markets take turns leading. The U.S. won the ebb and flow recently.  The S&P 500 dramatically outperformed emerging markets by 98% in the last five years.

Signs of a change in this trend are evident.

As has happened in most cycles, the U.S. dollar peaked right around the first interest rate hike.  One of the largest detractors from returns over the last few years for emerging markets has actually been their currencies, rather than just share prices.  Currency markets have turned around since February of 2016.

Prices bottomed at 10% lower than in the 2002 bear market, making them a great value 14 years later.

Earnings are also turning the corner, with the fastest six-month growth rate since 2011.

Finally, inflation is coming under control.  In Brazil, inflation was at 10.7% just a year ago and it has since fallen to 8.7%.  India also stabilized its inflation rate in the 5 to 6% range.  Price stability is an important attribute for countries to display for investors.

So what are the alternatives?  While U.S. stocks prices are high, our favorite stocks are in emerging markets. With lower valuations on both share prices and currencies, emerging market equities look appealing.  This is apparent as emerging markets outperformed the U.S. by 8% in 2016.  Considering the strong demographic and productivity trends, along with lower overall debt levels compared to developed markets, emerging markets have many tailwinds.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Economy

The U.S. economy is still growing, albeit at a modest pace. Consumer confidence hit the highest level in nine years. The University of Michigan Consumer Sentiment Index also backs this up.

When consumers are confident, they spend more money. In turn, this can act as a virtuous circle until an outside force acts upon it.

The presidential election and how the eventual winner impacts the economy is on investors’ minds. A few are worried about the election being the outside force that hits consumers.

One issue the incoming President will face is the likelihood of a recession at some point. By the time the new President takes office, this expansion will be closing in on eight years. The longest economic expansion ever for the U.S. was from 1991 until 2001. Simple math would tell us we are due within the next four years.

The chart below shows the federal government tax receipts as a percentage of total Gross Domestic Product (GDP). The increase in this rate over the past five years tells us it is a risk for the incoming President.

Taxes drain money out of the system. Today, it is taking money out at one of the highest rates in the last 30 years. With interest rates at the lowest level since the 1950s, we would prefer to see more fiscal stimulus or lower taxes. This would help buoy the economy.

The financial media watches the Federal Reserve with bated breath every time a governor speaks. Still, there is only so much that they can do. Maintaining low interest rates certainly helped the economy. There is dissension within the ranks at the Fed with three members voting to raise interest rates at the last meeting. We will wait to see what happens in the fourth quarter with the possibility of another interest rate hike this cycle, the last one being in December 2015.

Equity

Stock markets rallied across regions during the third quarter. Emerging markets were the top performers followed by developed international. The U.S. lagged, with domsetic small caps outpacing mid and large caps.

The chart below shows the sector performance on a year-to-date basis. Energy in the red line is the

top performer in 2016 after being the worst in 2015. The thin blue line for utilities and the thin   orange line for telecom peaked in July. Both were down during the quarter despite the broader market being up.

Last quarter we talked about the outperformance of yield-oriented sectors. In a few circles these became known as R.U.S.T. (Real Estate, Utilities, Staples (consumer), and Telecom). Most portfolio managers felt these areas were overvalued. This was due to the flow of cash into these sectors and inexpicable prices paid (hence the not so affectionate label).

The U.S. equity market was the best performer over the last five years, as shown in aqua below. Japan has come back down to earth after the stimulus package from 2014 wore off, as shown in green. Europe’s stocks, in orange, lagged both Japan and the U.S. Political issues from not being fiscally linked produced imbalances between Germany and the periphery countries. The biggest underperformer was emerging markets in violet.

In the past we discussed the cheap value in share prices and currencies for emerging markets. The chart above, however, is much simpler. Over the past five years, emerging markets has been the lowest performing region. Though it still turned in positive returns for investors. If the first rule of investing is “buy low and sell high,” which markets would an astute investor consider adding funds to?

The Aurum Asset Allocation Frameworks have strategic asset class targets for the long-term. Our tactical weights reflect value-based opportunities. This is where our research shows favorable conditions for an asset class.  Portfolios maintain a small underweight to developed markets in favor of emerging markets.

Fixed Income

Corporate credit spreads relative to comparable Treasuries decreased during the quarter. This allowed bonds to turn in a positive quarter, except for municipals.

Yields on the 10-year Treasury bottomed in the first week of July and rose 0.40% since, shown in orange. This is the third multi-month rise in yields over the past four years. Each period below is highlighted by grey vertical bars. In each case, Japan’s Government Bonds (JGBs in aqua) rose sharply just before U.S. yields perked up.

In 2013, the 10-year Treasury yield rose from 1.63% to 3.00% over seven months. In 2015, Treasury yields rose from 1.64% to 2.49% over five months. The sample size is quite small at only two, however, pressure on yields could continue higher for a few more months. The Federal Reserve’s rhetoric around raising interest rates in the fourth quarter is putting pressure on yields. Policy responses from Japan and Europe is as  well.

High yield bonds have done well this year. This followed a poor performance in 2015, driven by the energy sector.  Because of this, prices started  out at distressed prices for energy. The credit spreads were comparable to the distress in telecom in 2001 and financials in 2008. The graph below shows the spike in yields for each of these sectors at those points in time.

With the price of  oil stabilizing  and doubling from $26 per barrel to $50 barrel, the price of stocks and bonds for energy came roaring back.

The Aurum Asset Allocation Frameworks maintain fixed income allocations at the strategic targets.

Our preference remains for fixed income securities collateralized by assets.   This provides an extra   layer of protection on cash flows or yield for our fixed income.

Alternative Investments

During the third quarter, hedge funds led the way as credit and equity-oriented strategies did well. The reversal in bond yields hurt trend following managers. REITs fell while increasing inflation expectations helped TIPS.

Below is the yield of the Barclay’s TIPS index. TIPS stands for Treasury Inflation Protected Securities. The unique aspect of TIPS is that the principal price of the bond adjusts annually based on the consumer price inflation (CPI) index. With inflation averaging 2.2% over the past two decades, TIPS offered a great value in the early to mid-2000s with a yield well above inflation.

Aurum Asset Allocation Frameworks

Inflation has actually been running below the yield of TIPS lately. This means investors are locking in a negative real yield. So today, this unique asset class  does  not  look attractive.

We increased our underweight to diversified strategies during the quarter as one of our managers retired. REITs and TIPS maintained a zero percent weight.

Conclusion

There are investment opportunities for those willing to look at uncomfortable places. Equity momentum is positive across regions. The back-up in interest rates could offer up compelling value in fixed income as well. The election is weighing on the minds of investors, however, historically the party leading the White House has little correlation to the performance of markets. Marking portfolio decisions based on politics just does not mix. We will stick to a diversified approach across asset classes.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

As the stock market pushes to new highs, the Dow Jones Industrial Average Index is nearing a level it never breached before – 20,000.  Financial news anchors are downright giddy (so we hear, watching too much CNBC can rot your eyes).

There is something satisfying about round numbers.  Per a News Works article, SAT takers are more likely to retake the test if they fall just short of a round number.  Major League baseball players are four times as likely to end the season with a .300 batting average than .299.

It is how we talk about age, being in our 30s, 40s or 50s.  It is how we think about numbers all the time. So why this obsession with round numbers and the base of 10 number system?

According to Eugenia Cheng, a scientist at the School of the Art Institute of Chicago, “It’s very intimately linked to the fact we have 10 fingers.”  Experts agree that the evolutionary accident of humans having ten fingers for counting drives our obsession with a base-10 number system.  Why do we have ten fingers (and ten toes)?  One theory is the Limb Law, which states that based on the length of the limbs (arm), animals develop an optimal number of further limbs (in this case, fingers).  Based on the size and length of human arms, five fingers on each hand turns out to be optimal.

We fixate on round numbers due to our own selves.  And this is partly why we care about Dow 20,000.

The Dow Jones Industrial Average is a price-based index.  The price of all the stocks are added together to come up with the Dow’s price.  The actual size of the company does not matter, the dollar value of the stock price is what is important.  This makes it an imperfect measure of stock market performance.

As an investor, most important is the percentage move of an index, not the dollar-based price move.

Let’s show why this matters.  Goldman Sachs’ stock price is $243.  It is the highest price stock of the 30 companies in the Dow Jones Industrial Average.  Thus, it is the largest percentage weight of the index at 8.33%.  Yet, it is not the largest company by market value (at $99 billion) in the U.S. That honor goes to Apple whose value is $626 billion.   Goldman Sachs is the 45th largest company by market value.  The S&P 500 is an index based on market value.  Within the S&P 500, Goldman Sachs has a weight of 0.46%, or less than half a percent.  It is 18 times larger in the Dow Jones Industrial Average and its daily changes affect it that much more.  This is significant because the S&P 500 is the most popular index and most tracked by mutual funds and exchange-traded funds (ETFs).

There are other ways to consider the significance of reaching milestones or all-time highs in the stock market.  One could inflation adjust the index by dividing by the consumer price index to get a ‘real’ value of the stock market.  Alternatively, most quoted price indices exclude dividends, which is not really a true representation of the experience of a ‘buy and hold’ investor.  Looking at a ‘total return’ would be more accurate.

Setting new highs means equity portfolio values are also setting new high-water marks.  The nostalgia of passing the round numbers also holds some significance.  People remember the ill-timed book Dow 40,000, published in 1999 during the midst of the tech bubble.  Finally, 17 years later and flirting with Dow 20,000, we are half way there!

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Sources: http://www.newsworks.org/index.php/local/the-pulse/80394-10-50-100-why-do-we-find-comfort-in-round-numbers

http://www.science20.com/mark_changizi/why_do_we_have_ten_fingers

The terms growth and value are often used to describe two different investment strategies, yet many investors may want both qualities in an investment. Famed investor Warren Buffett put it this way in a 2015 interview: “I always say if you aren’t investing for value, what are you investing for? And the idea that value and growth are two different things makes no sense…. Growth is part of the value equation.”¹

Even so, analysts may look at specific stocks as offering more growth potential than value, and vice versa. And these concepts are used to construct many mutual funds and exchange-traded funds (ETFs). So it’s helpful to understand the opposing ideas, even if you want the best of both in your portfolio.

Poised to grow?

As the name suggests, growth stocks are associated with companies that appear to have above-average growth potential. These companies might be on the verge of a market breakthrough or acquisition, or they may occupy a strong position in a growing industry.

Growth companies may place more emphasis on reinvesting profits than on paying dividends (although many large growth companies do offer dividends). Investors hope to benefit from future capital appreciation of growth stocks, which tend to be considered higher risk than value stocks. However, it’s equally important for growth and value stocks to have strong fundamentals.

Undervalued?

Value stocks are associated with companies that appear to be undervalued by the market or are in an industry that is currently out of favor. Unlike growth stocks, which might seem expensive and overvalued, value stocks may be priced lower in relation to their earnings, assets, or growth potential.

Established companies are more likely than younger companies to be considered value stocks, and these firms may emphasize paying dividends over reinvesting profits. An investor who purchases a value stock typically expects the broader market to eventually recognize the company’s full potential, which may result in rising share prices. One risk with this approach is that a stock considered to be undervalued because of legal or management difficulties or tough competition might not be able to recover from the setback.

Focused funds

Identifying specific growth or value investments requires time, knowledge, and experience to analyze stock data. A more convenient and accessible way to add growth or value stocks to your portfolio may be through mutual funds or ETFs that focus on these categories. Such funds often have the word “growth” or “value” in their names. However, there could be a wide variety of objectives and stock holdings among funds labeled growth or value.

Also keep in mind that you might find growth, value, or both in a broad range of investments that do not employ growth or value strategies.

Diversification

Holding growth and value stocks and/or funds is one way to diversify the stock portion of your portfolio. Over the past 20 years, the average annual return for value stocks was about 1.5 percentage points higher than that of growth stocks (8.54% versus 7.02%). Yet growth stocks outperformed value stocks in eight of those years — in some years by large margins. This suggests that growth and value stocks may respond differently to varying market conditions.²

Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

The return and principal value of stocks, mutual funds, and ETFs fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares.

Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Stay up-to-date with the latest business trends, tips and revenue-generating ideas affecting you and your business by subscribing to the Skoda Minotti Blog or by following us on LinkedIn, Twitter @skodaminotti and Facebook.


Advisory Services offered through Investment Advisors, a division of ProEquities, Inc., a Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member, FINRA & SIPC. Skoda Minotti is independent of ProEquities, Inc.

¹CNBC.com, March 2, 2015

² Thomson Reuters, 2016, for the period 9/30/1996 to 9/30/2016. Growth stocks are represented by the Russell 3000 Growth Index. Value stocks are represented by the Russell 3000 Value Index. The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Rates of return will vary over time, particularly for long-term investments. Past performance is not a guarantee of future results.

Tax planning is probably something business owners think about twice a year: when the return is being prepared and possibly at the end of the year. This, however, is short-sighted. Now is a great time to evaluate your tax situation and implement some strategic measures. We suggest five approaches worth considering.

1) Review Income Tax Payments – If your model is to pay income taxes on business profits through estimated taxes, you have two more times to get it right: September 15, 2017 and January 16, 2018. Review the amounts with your accountant to prevent overpaying—why offer the government an interest-free loan? Then there is underpaying, which can cause costly tax interest and/or penalties. Remember that estimated taxes include not only regular income taxes (including the alternative minimum tax) but may also include:

• Self-employment tax
• .9% additional Medicare tax on earned income
• 3.8% additional Medicare tax on net investment income

2) Assess Your Profitability – Consider a few strategies to boost tax savings if 2017 is revealing itself to be a solid year for you:

• Buy Equipment. In 2017, you can expense up to $510,000 worth of equipment purchases (even if you finance them) instead of depreciating the cost over a number of years. This amount is phased out dollar for dollar to the extent your eligible property exceeds $2,030,000.
• Hire Wisely. As you increase your staffing, bear in mind that the work opportunity credit rewards you for hiring someone from a targeted group, such as a qualified veteran.
• Create a Qualified Retirement Plan. You can cut your current tax bill through contributions to a qualified retirement plan. There are several plan options, and the one to choose depends on whether you have employees and how much of the contributions the business can afford to shoulder.

3) Issue Stock – If you’re a qualifying C corporation (with gross assets less than $50 million in addition to other restrictions) in manufacturing, technology, retail or wholesale, you may qualify to issue stock (referred to as a small business stock, or Section 1202 stock) that will permit the shareholder to eventually obtain tax-free treatment for any capital gain. If you issue the stock now and it’s held for more than five years, then all of the gain is tax free. The stock must be acquired in exchange for cash, property or services (not received through a gift or inheritance). It can be used to bring in new investors or reward employees.

4) Meet With Your Tax Advisor – Most small business owners use CPAs or other tax advisors to prepare and file their returns. These professionals also can serve as business advisors throughout the year, offering guidance on what businesses can do to maximize profitability while minimizing taxes. Schedule a meeting to review your profits and losses, and craft a tax plan with current information, while also considering projections and past performance.

5) Expand Your Research and Development (R&D) – It’s not only big companies like drug manufacturers and technology companies that invest in R&D. Whether you engage in R&D to develop a product or to identify new methods for your operations by, for example, creating internal software, you may qualify tax credits. This could help to underwrite the cost for the research.

A “qualified small business” can choose to use the credit as an offset to the employer’s share of Social Security taxes (up to $250,000) rather than using it against income taxes. Businesses that qualify are those with less than $5 million in gross receipts for the current year and no gross receipts for any year preceding the fifth year prior to the current year. For example, a business with $4 million in receipts in 2017 and no gross receipts prior to 2012 may use this option.

In summary, the key takeaway here is to prevent missing an opportunity to review your tax position and determine the strategies you can use between now and the end of the year to optimize your 2017 tax bill.

Do you have questions about how to approach midyear tax-saving strategies? Please contact Jim Forbes at 440-449-6800 or jforbes@skodaminotti.com.

No doubt you’ve seen headlines reporting that a particular stock index is up or down. But do you know what an index is, and how understanding the nuts and bolts of a specific index may be helpful to you?

An index is simply a way to measure and report the fluctuations of a pool of securities or a representative segment of a market. An index is developed by a company that sets specific criteria to determine which securities are included in the index based on factors such as a company’s size or location, or the liquidity of its stock. For example, the S&P 500 is an index made up of mostly large-cap U.S.-based companies that Standard & Poor’s considers to be leading representatives of a cross-section of industries.

The company that develops the index tracks the performance of its components and aggregates the data to produce a single figure that represents the index as a whole. Virtually every asset class is tracked by at least one index, but because of the size and variety of the stock market, there are more stock indexes than any other type. It’s important to note that the performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index.

Comparing apples to oranges

Since indexes encompass a wide range of securities, it’s important to know what segment of the market a particular index covers. For instance, a composite index follows a specific stock exchange. The Nasdaq Composite Index includes all the stocks listed on the Nasdaq market. Conversely, sector indexes track securities in a specific industry.

Even indexes that include the same securities may not operate in precisely the same way. Generally, indexes tend to be either price-weighted or market capitalization-weighted. If an index is price-weighted, such as the Dow Jones Industrial Average, the impact of each stock on the overall average is proportional to its price compared to other stocks in the index. With a price-weighted index, the highest-priced stocks would have the most impact on the average. For example, a 1 percentage point drop in the price of a stock selling for $80 per share would have more impact on the overall index’s performance than a 1 percentage point drop in the price of a stock that had been selling for $40 a share.

If an index is market capitalization-weighted or market value-weighted, such as the Nasdaq Composite Index or the S&P 500 Composite Index, the average of the index is adjusted to take into account the relative size of each company (its market cap) to reflect its importance to the index. Stocks with a larger market capitalization have a greater influence on how the index performs than stocks with a smaller market capitalization. For example, if the stock of a $10 billion market-cap company drops by 1 percentage point, it will drag down the index’s performance more than a 1 percentage point drop in the share price of a $1 billion market-cap company.

Though an index adheres to a set of guidelines for selection of the securities it includes, the company that oversees the index generally reviews the security selection periodically and may make occasional changes. For example, some indexes may rebalance if an individual security grows so large that it dominates the index. Others have a limit on how much of the index can be devoted to a particular sector or industry, and may rebalance if the proportion gets skewed.

Indexes are worth watching

Stock indexes can provide valuable information for the individual investor. If checked regularly, an index can provide information that may help you stay abreast of how the stock market in general, or a particular segment of it, is faring. However, understanding the differences between indexes and how each one works will help you make better use of the information they provide. All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

Stay up-to-date with the latest business trends, tips and revenue-generating ideas affecting you and your business by subscribing to the Skoda Minotti Blog or by following us on LinkedIn, Twitter @skodaminotti, and Facebook

Advisory Services offered through Investment Advisors, a division of ProEquities, Inc., a Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member, FINRA & SIPC. Skoda Minotti is independent of ProEquities, Inc.

Despite the high stock prices and a great run in bond prices, investors can hardly be described as exuberant.  Perhaps it is because they look at the investment landscape and do not see much that they like.

Bond yields fell from 15.75% in 1981 to 1.51% today (see below).

By definition, this yield is the expected return on a risk-free 10-year Treasury bond held to maturity.  It is tough to get excited about these yields as well as meeting financial planning objectives.

It is easy to argue that stocks are priced above fair value.  Price-to-sales, price-to-earnings, price-to-cash flow – all traditional ways to measure relative value – are well above their historical medians.

After looking at these ideas, people are throwing up their hands and asking, “what is the alternative?”

We look at the world a little differently.  The first rule of investing?  Buy low, sell high.  Where have prices been low for a while?  It is emerging markets.

Historically, there are 5 to 7 year cycles where emerging markets and developed markets take turns leading. The U.S. won the ebb and flow recently.  The S&P 500 dramatically outperformed emerging markets by 98% in the last five years.

Signs of a change in this trend are evident.

As has happened in most cycles, the U.S. dollar peaked right around the first interest rate hike.  One of the largest detractors from returns over the last few years for emerging markets has actually been their currencies, rather than just share prices.  Currency markets have turned around since February of 2016.

Prices bottomed at 10% lower than in the 2002 bear market, making them a great value 14 years later.

Earnings are also turning the corner, with the fastest six-month growth rate since 2011.

Finally, inflation is coming under control.  In Brazil, inflation was at 10.7% just a year ago and it has since fallen to 8.7%.  India also stabilized its inflation rate in the 5 to 6% range.  Price stability is an important attribute for countries to display for investors.

So what are the alternatives?  While U.S. stocks prices are high, our favorite stocks are in emerging markets. With lower valuations on both share prices and currencies, emerging market equities look appealing.  This is apparent as emerging markets outperformed the U.S. by 8% in 2016.  Considering the strong demographic and productivity trends, along with lower overall debt levels compared to developed markets, emerging markets have many tailwinds.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Economy

The U.S. economy is still growing, albeit at a modest pace. Consumer confidence hit the highest level in nine years. The University of Michigan Consumer Sentiment Index also backs this up.

When consumers are confident, they spend more money. In turn, this can act as a virtuous circle until an outside force acts upon it.

The presidential election and how the eventual winner impacts the economy is on investors’ minds. A few are worried about the election being the outside force that hits consumers.

One issue the incoming President will face is the likelihood of a recession at some point. By the time the new President takes office, this expansion will be closing in on eight years. The longest economic expansion ever for the U.S. was from 1991 until 2001. Simple math would tell us we are due within the next four years.

The chart below shows the federal government tax receipts as a percentage of total Gross Domestic Product (GDP). The increase in this rate over the past five years tells us it is a risk for the incoming President.

Taxes drain money out of the system. Today, it is taking money out at one of the highest rates in the last 30 years. With interest rates at the lowest level since the 1950s, we would prefer to see more fiscal stimulus or lower taxes. This would help buoy the economy.

The financial media watches the Federal Reserve with bated breath every time a governor speaks. Still, there is only so much that they can do. Maintaining low interest rates certainly helped the economy. There is dissension within the ranks at the Fed with three members voting to raise interest rates at the last meeting. We will wait to see what happens in the fourth quarter with the possibility of another interest rate hike this cycle, the last one being in December 2015.

Equity

Stock markets rallied across regions during the third quarter. Emerging markets were the top performers followed by developed international. The U.S. lagged, with domsetic small caps outpacing mid and large caps.

The chart below shows the sector performance on a year-to-date basis. Energy in the red line is the

top performer in 2016 after being the worst in 2015. The thin blue line for utilities and the thin   orange line for telecom peaked in July. Both were down during the quarter despite the broader market being up.

Last quarter we talked about the outperformance of yield-oriented sectors. In a few circles these became known as R.U.S.T. (Real Estate, Utilities, Staples (consumer), and Telecom). Most portfolio managers felt these areas were overvalued. This was due to the flow of cash into these sectors and inexpicable prices paid (hence the not so affectionate label).

The U.S. equity market was the best performer over the last five years, as shown in aqua below. Japan has come back down to earth after the stimulus package from 2014 wore off, as shown in green. Europe’s stocks, in orange, lagged both Japan and the U.S. Political issues from not being fiscally linked produced imbalances between Germany and the periphery countries. The biggest underperformer was emerging markets in violet.

In the past we discussed the cheap value in share prices and currencies for emerging markets. The chart above, however, is much simpler. Over the past five years, emerging markets has been the lowest performing region. Though it still turned in positive returns for investors. If the first rule of investing is “buy low and sell high,” which markets would an astute investor consider adding funds to?

The Aurum Asset Allocation Frameworks have strategic asset class targets for the long-term. Our tactical weights reflect value-based opportunities. This is where our research shows favorable conditions for an asset class.  Portfolios maintain a small underweight to developed markets in favor of emerging markets.

Fixed Income

Corporate credit spreads relative to comparable Treasuries decreased during the quarter. This allowed bonds to turn in a positive quarter, except for municipals.

Yields on the 10-year Treasury bottomed in the first week of July and rose 0.40% since, shown in orange. This is the third multi-month rise in yields over the past four years. Each period below is highlighted by grey vertical bars. In each case, Japan’s Government Bonds (JGBs in aqua) rose sharply just before U.S. yields perked up.

In 2013, the 10-year Treasury yield rose from 1.63% to 3.00% over seven months. In 2015, Treasury yields rose from 1.64% to 2.49% over five months. The sample size is quite small at only two, however, pressure on yields could continue higher for a few more months. The Federal Reserve’s rhetoric around raising interest rates in the fourth quarter is putting pressure on yields. Policy responses from Japan and Europe is as  well.

High yield bonds have done well this year. This followed a poor performance in 2015, driven by the energy sector.  Because of this, prices started  out at distressed prices for energy. The credit spreads were comparable to the distress in telecom in 2001 and financials in 2008. The graph below shows the spike in yields for each of these sectors at those points in time.

With the price of  oil stabilizing  and doubling from $26 per barrel to $50 barrel, the price of stocks and bonds for energy came roaring back.

The Aurum Asset Allocation Frameworks maintain fixed income allocations at the strategic targets.

Our preference remains for fixed income securities collateralized by assets.   This provides an extra   layer of protection on cash flows or yield for our fixed income.

Alternative Investments

During the third quarter, hedge funds led the way as credit and equity-oriented strategies did well. The reversal in bond yields hurt trend following managers. REITs fell while increasing inflation expectations helped TIPS.

Below is the yield of the Barclay’s TIPS index. TIPS stands for Treasury Inflation Protected Securities. The unique aspect of TIPS is that the principal price of the bond adjusts annually based on the consumer price inflation (CPI) index. With inflation averaging 2.2% over the past two decades, TIPS offered a great value in the early to mid-2000s with a yield well above inflation.

Aurum Asset Allocation Frameworks

Inflation has actually been running below the yield of TIPS lately. This means investors are locking in a negative real yield. So today, this unique asset class  does  not  look attractive.

We increased our underweight to diversified strategies during the quarter as one of our managers retired. REITs and TIPS maintained a zero percent weight.

Conclusion

There are investment opportunities for those willing to look at uncomfortable places. Equity momentum is positive across regions. The back-up in interest rates could offer up compelling value in fixed income as well. The election is weighing on the minds of investors, however, historically the party leading the White House has little correlation to the performance of markets. Marking portfolio decisions based on politics just does not mix. We will stick to a diversified approach across asset classes.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

As the stock market pushes to new highs, the Dow Jones Industrial Average Index is nearing a level it never breached before – 20,000.  Financial news anchors are downright giddy (so we hear, watching too much CNBC can rot your eyes).

There is something satisfying about round numbers.  Per a News Works article, SAT takers are more likely to retake the test if they fall just short of a round number.  Major League baseball players are four times as likely to end the season with a .300 batting average than .299.

It is how we talk about age, being in our 30s, 40s or 50s.  It is how we think about numbers all the time. So why this obsession with round numbers and the base of 10 number system?

According to Eugenia Cheng, a scientist at the School of the Art Institute of Chicago, “It’s very intimately linked to the fact we have 10 fingers.”  Experts agree that the evolutionary accident of humans having ten fingers for counting drives our obsession with a base-10 number system.  Why do we have ten fingers (and ten toes)?  One theory is the Limb Law, which states that based on the length of the limbs (arm), animals develop an optimal number of further limbs (in this case, fingers).  Based on the size and length of human arms, five fingers on each hand turns out to be optimal.

We fixate on round numbers due to our own selves.  And this is partly why we care about Dow 20,000.

The Dow Jones Industrial Average is a price-based index.  The price of all the stocks are added together to come up with the Dow’s price.  The actual size of the company does not matter, the dollar value of the stock price is what is important.  This makes it an imperfect measure of stock market performance.

As an investor, most important is the percentage move of an index, not the dollar-based price move.

Let’s show why this matters.  Goldman Sachs’ stock price is $243.  It is the highest price stock of the 30 companies in the Dow Jones Industrial Average.  Thus, it is the largest percentage weight of the index at 8.33%.  Yet, it is not the largest company by market value (at $99 billion) in the U.S. That honor goes to Apple whose value is $626 billion.   Goldman Sachs is the 45th largest company by market value.  The S&P 500 is an index based on market value.  Within the S&P 500, Goldman Sachs has a weight of 0.46%, or less than half a percent.  It is 18 times larger in the Dow Jones Industrial Average and its daily changes affect it that much more.  This is significant because the S&P 500 is the most popular index and most tracked by mutual funds and exchange-traded funds (ETFs).

There are other ways to consider the significance of reaching milestones or all-time highs in the stock market.  One could inflation adjust the index by dividing by the consumer price index to get a ‘real’ value of the stock market.  Alternatively, most quoted price indices exclude dividends, which is not really a true representation of the experience of a ‘buy and hold’ investor.  Looking at a ‘total return’ would be more accurate.

Setting new highs means equity portfolio values are also setting new high-water marks.  The nostalgia of passing the round numbers also holds some significance.  People remember the ill-timed book Dow 40,000, published in 1999 during the midst of the tech bubble.  Finally, 17 years later and flirting with Dow 20,000, we are half way there!

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Sources: http://www.newsworks.org/index.php/local/the-pulse/80394-10-50-100-why-do-we-find-comfort-in-round-numbers

http://www.science20.com/mark_changizi/why_do_we_have_ten_fingers

The terms growth and value are often used to describe two different investment strategies, yet many investors may want both qualities in an investment. Famed investor Warren Buffett put it this way in a 2015 interview: “I always say if you aren’t investing for value, what are you investing for? And the idea that value and growth are two different things makes no sense…. Growth is part of the value equation.”¹

Even so, analysts may look at specific stocks as offering more growth potential than value, and vice versa. And these concepts are used to construct many mutual funds and exchange-traded funds (ETFs). So it’s helpful to understand the opposing ideas, even if you want the best of both in your portfolio.

Poised to grow?

As the name suggests, growth stocks are associated with companies that appear to have above-average growth potential. These companies might be on the verge of a market breakthrough or acquisition, or they may occupy a strong position in a growing industry.

Growth companies may place more emphasis on reinvesting profits than on paying dividends (although many large growth companies do offer dividends). Investors hope to benefit from future capital appreciation of growth stocks, which tend to be considered higher risk than value stocks. However, it’s equally important for growth and value stocks to have strong fundamentals.

Undervalued?

Value stocks are associated with companies that appear to be undervalued by the market or are in an industry that is currently out of favor. Unlike growth stocks, which might seem expensive and overvalued, value stocks may be priced lower in relation to their earnings, assets, or growth potential.

Established companies are more likely than younger companies to be considered value stocks, and these firms may emphasize paying dividends over reinvesting profits. An investor who purchases a value stock typically expects the broader market to eventually recognize the company’s full potential, which may result in rising share prices. One risk with this approach is that a stock considered to be undervalued because of legal or management difficulties or tough competition might not be able to recover from the setback.

Focused funds

Identifying specific growth or value investments requires time, knowledge, and experience to analyze stock data. A more convenient and accessible way to add growth or value stocks to your portfolio may be through mutual funds or ETFs that focus on these categories. Such funds often have the word “growth” or “value” in their names. However, there could be a wide variety of objectives and stock holdings among funds labeled growth or value.

Also keep in mind that you might find growth, value, or both in a broad range of investments that do not employ growth or value strategies.

Diversification

Holding growth and value stocks and/or funds is one way to diversify the stock portion of your portfolio. Over the past 20 years, the average annual return for value stocks was about 1.5 percentage points higher than that of growth stocks (8.54% versus 7.02%). Yet growth stocks outperformed value stocks in eight of those years — in some years by large margins. This suggests that growth and value stocks may respond differently to varying market conditions.²

Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

The return and principal value of stocks, mutual funds, and ETFs fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares.

Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Stay up-to-date with the latest business trends, tips and revenue-generating ideas affecting you and your business by subscribing to the Skoda Minotti Blog or by following us on LinkedIn, Twitter @skodaminotti and Facebook.


Advisory Services offered through Investment Advisors, a division of ProEquities, Inc., a Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member, FINRA & SIPC. Skoda Minotti is independent of ProEquities, Inc.

¹CNBC.com, March 2, 2015

² Thomson Reuters, 2016, for the period 9/30/1996 to 9/30/2016. Growth stocks are represented by the Russell 3000 Growth Index. Value stocks are represented by the Russell 3000 Value Index. The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Rates of return will vary over time, particularly for long-term investments. Past performance is not a guarantee of future results.

Tax planning is probably something business owners think about twice a year: when the return is being prepared and possibly at the end of the year. This, however, is short-sighted. Now is a great time to evaluate your tax situation and implement some strategic measures. We suggest five approaches worth considering.

1) Review Income Tax Payments – If your model is to pay income taxes on business profits through estimated taxes, you have two more times to get it right: September 15, 2017 and January 16, 2018. Review the amounts with your accountant to prevent overpaying—why offer the government an interest-free loan? Then there is underpaying, which can cause costly tax interest and/or penalties. Remember that estimated taxes include not only regular income taxes (including the alternative minimum tax) but may also include:

• Self-employment tax
• .9% additional Medicare tax on earned income
• 3.8% additional Medicare tax on net investment income

2) Assess Your Profitability – Consider a few strategies to boost tax savings if 2017 is revealing itself to be a solid year for you:

• Buy Equipment. In 2017, you can expense up to $510,000 worth of equipment purchases (even if you finance them) instead of depreciating the cost over a number of years. This amount is phased out dollar for dollar to the extent your eligible property exceeds $2,030,000.
• Hire Wisely. As you increase your staffing, bear in mind that the work opportunity credit rewards you for hiring someone from a targeted group, such as a qualified veteran.
• Create a Qualified Retirement Plan. You can cut your current tax bill through contributions to a qualified retirement plan. There are several plan options, and the one to choose depends on whether you have employees and how much of the contributions the business can afford to shoulder.

3) Issue Stock – If you’re a qualifying C corporation (with gross assets less than $50 million in addition to other restrictions) in manufacturing, technology, retail or wholesale, you may qualify to issue stock (referred to as a small business stock, or Section 1202 stock) that will permit the shareholder to eventually obtain tax-free treatment for any capital gain. If you issue the stock now and it’s held for more than five years, then all of the gain is tax free. The stock must be acquired in exchange for cash, property or services (not received through a gift or inheritance). It can be used to bring in new investors or reward employees.

4) Meet With Your Tax Advisor – Most small business owners use CPAs or other tax advisors to prepare and file their returns. These professionals also can serve as business advisors throughout the year, offering guidance on what businesses can do to maximize profitability while minimizing taxes. Schedule a meeting to review your profits and losses, and craft a tax plan with current information, while also considering projections and past performance.

5) Expand Your Research and Development (R&D) – It’s not only big companies like drug manufacturers and technology companies that invest in R&D. Whether you engage in R&D to develop a product or to identify new methods for your operations by, for example, creating internal software, you may qualify tax credits. This could help to underwrite the cost for the research.

A “qualified small business” can choose to use the credit as an offset to the employer’s share of Social Security taxes (up to $250,000) rather than using it against income taxes. Businesses that qualify are those with less than $5 million in gross receipts for the current year and no gross receipts for any year preceding the fifth year prior to the current year. For example, a business with $4 million in receipts in 2017 and no gross receipts prior to 2012 may use this option.

In summary, the key takeaway here is to prevent missing an opportunity to review your tax position and determine the strategies you can use between now and the end of the year to optimize your 2017 tax bill.

Do you have questions about how to approach midyear tax-saving strategies? Please contact Jim Forbes at 440-449-6800 or jforbes@skodaminotti.com.

No doubt you’ve seen headlines reporting that a particular stock index is up or down. But do you know what an index is, and how understanding the nuts and bolts of a specific index may be helpful to you?

An index is simply a way to measure and report the fluctuations of a pool of securities or a representative segment of a market. An index is developed by a company that sets specific criteria to determine which securities are included in the index based on factors such as a company’s size or location, or the liquidity of its stock. For example, the S&P 500 is an index made up of mostly large-cap U.S.-based companies that Standard & Poor’s considers to be leading representatives of a cross-section of industries.

The company that develops the index tracks the performance of its components and aggregates the data to produce a single figure that represents the index as a whole. Virtually every asset class is tracked by at least one index, but because of the size and variety of the stock market, there are more stock indexes than any other type. It’s important to note that the performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index.

Comparing apples to oranges

Since indexes encompass a wide range of securities, it’s important to know what segment of the market a particular index covers. For instance, a composite index follows a specific stock exchange. The Nasdaq Composite Index includes all the stocks listed on the Nasdaq market. Conversely, sector indexes track securities in a specific industry.

Even indexes that include the same securities may not operate in precisely the same way. Generally, indexes tend to be either price-weighted or market capitalization-weighted. If an index is price-weighted, such as the Dow Jones Industrial Average, the impact of each stock on the overall average is proportional to its price compared to other stocks in the index. With a price-weighted index, the highest-priced stocks would have the most impact on the average. For example, a 1 percentage point drop in the price of a stock selling for $80 per share would have more impact on the overall index’s performance than a 1 percentage point drop in the price of a stock that had been selling for $40 a share.

If an index is market capitalization-weighted or market value-weighted, such as the Nasdaq Composite Index or the S&P 500 Composite Index, the average of the index is adjusted to take into account the relative size of each company (its market cap) to reflect its importance to the index. Stocks with a larger market capitalization have a greater influence on how the index performs than stocks with a smaller market capitalization. For example, if the stock of a $10 billion market-cap company drops by 1 percentage point, it will drag down the index’s performance more than a 1 percentage point drop in the share price of a $1 billion market-cap company.

Though an index adheres to a set of guidelines for selection of the securities it includes, the company that oversees the index generally reviews the security selection periodically and may make occasional changes. For example, some indexes may rebalance if an individual security grows so large that it dominates the index. Others have a limit on how much of the index can be devoted to a particular sector or industry, and may rebalance if the proportion gets skewed.

Indexes are worth watching

Stock indexes can provide valuable information for the individual investor. If checked regularly, an index can provide information that may help you stay abreast of how the stock market in general, or a particular segment of it, is faring. However, understanding the differences between indexes and how each one works will help you make better use of the information they provide. All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

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Advisory Services offered through Investment Advisors, a division of ProEquities, Inc., a Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member, FINRA & SIPC. Skoda Minotti is independent of ProEquities, Inc.

Despite the high stock prices and a great run in bond prices, investors can hardly be described as exuberant.  Perhaps it is because they look at the investment landscape and do not see much that they like.

Bond yields fell from 15.75% in 1981 to 1.51% today (see below).

By definition, this yield is the expected return on a risk-free 10-year Treasury bond held to maturity.  It is tough to get excited about these yields as well as meeting financial planning objectives.

It is easy to argue that stocks are priced above fair value.  Price-to-sales, price-to-earnings, price-to-cash flow – all traditional ways to measure relative value – are well above their historical medians.

After looking at these ideas, people are throwing up their hands and asking, “what is the alternative?”

We look at the world a little differently.  The first rule of investing?  Buy low, sell high.  Where have prices been low for a while?  It is emerging markets.

Historically, there are 5 to 7 year cycles where emerging markets and developed markets take turns leading. The U.S. won the ebb and flow recently.  The S&P 500 dramatically outperformed emerging markets by 98% in the last five years.

Signs of a change in this trend are evident.

As has happened in most cycles, the U.S. dollar peaked right around the first interest rate hike.  One of the largest detractors from returns over the last few years for emerging markets has actually been their currencies, rather than just share prices.  Currency markets have turned around since February of 2016.

Prices bottomed at 10% lower than in the 2002 bear market, making them a great value 14 years later.

Earnings are also turning the corner, with the fastest six-month growth rate since 2011.

Finally, inflation is coming under control.  In Brazil, inflation was at 10.7% just a year ago and it has since fallen to 8.7%.  India also stabilized its inflation rate in the 5 to 6% range.  Price stability is an important attribute for countries to display for investors.

So what are the alternatives?  While U.S. stocks prices are high, our favorite stocks are in emerging markets. With lower valuations on both share prices and currencies, emerging market equities look appealing.  This is apparent as emerging markets outperformed the U.S. by 8% in 2016.  Considering the strong demographic and productivity trends, along with lower overall debt levels compared to developed markets, emerging markets have many tailwinds.

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.