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The Market and the Economy

Indexes and Benchmarks

The following table reflects the performance of a selection of frequently used indices and benchmarks for the 2016 calendar year:

Index %Gain/Loss 2016
S & P 500 12.0
Dow Jones Industrials 16.5
Nasdaq (high-tech stocks) 7.5
Russell 2000 (small cap stocks) 19.5
Russell 3000 (broad market) 10.4
Dow Jones Global Stock Index 6.1
Dow Jones Global Stock Market (Ex-US) 1.2
Dow Jones Islamic Market Index 3.0
MSCI Emerging Market Equities 11.2
Barclay's US Aggregate Bond Index
2.7
Barclay's Global Aggregate Bond Index 2.5
US Treasury Inflation Protected Securities 4.7
WCII World Balanced Investments Index* 4.7
Bloomberg Commodity Index 10.3
DJ US Select REIT (Real Estate) 5.7
Alerian MLP Index # 18.3
Eurekahedge Hedge (Fund of Funds) Index (0.2)
US Money Market Funds (taxable) 0.1
* Portfolio benchmark reflecting a 60% holding of the Dow Jones Global Stock Index and a 40% position in the Barclay World Aggregate Bond Index. # Master Limited Partnerships (oil/gas pipeline firms).

2016 was a year to have been invested in large-cap US equities. Commodities and emerging market equities also performed well. However, outside of US equities, both stocks and bonds performed only marginally well at best. For example, European equities registered negative returns (-2.6%) and Asian equities returned a paltry 2.4%, with China (-1.25%) falling into negative territory for 2016. As can be seen in the table above, bonds also provided mediocre returns for the year.

A wide disparity of performance was also observed in US sector returns with the energy (+19.5%), Utilities (+15.8%) and Technology (+13.1%) sectors performing outstandingly while the Financial Services (+0.5%), Health care (+1.2%) and the Consumer sectors (+3.5%) registering very lackluster returns. Worst of all sub-sector performers was the biotechnology industry, which turned in a negative 15.6% return for the year. However, this industry is poised for a recovery in 2017 and is a long-term hold for the portfolios for which sector/industry investing is appropriate.

The Markets and the Economy

Given the president-elect's expressed economic and taxation policies, it is likely that the investment risk/reward continuum has shifted. Higher volatility risk accompanied by higher (hopefully) potential rewards (if the president's policies are effected and succeed in generating strong economic growth) appear to be our (and the world's) new paradigm.

The US economy appears to be growing, albeit slowly; however, Chinese economic growth has been slowing as is Japan's and the Euro-zone economies are in a state of turmoil and uncertainty.

These factors, coupled with the fact that equity markets are overdue for a serious correction of at least 10%, or even a bear market capitulation (a downturn of 20% or greater in the S&P 500 equity index) and the current high price-to-earnings ratios of the major market indices, with the Dow Jones Industrials now trading at a multiple of greater than 21 compared to last year's 15 and the S&P 500 trading at a PE ratio of greater than 25, when compared to last year's 21, militates for a cautious approach to investing.

Moreover, in a more philosophical vein, although there is nothing inherently dangerous or mystifying about investments whose value is based upon the value of an underlying linked security (as long as the values of the underlying securities are known and are reflective of reality), approximately a quadrillion (yes, that is with a Q) dollars of derivative securities currently exist in the world marketplace. Many of these securities are linked, one supporting another or a series of other securities in a daisy-chain matrix of interconnected investments. In some cases, the value of the underlying security(ies) either cannot be known with certainty or depends upon a value that is determined by market forces. Supporting this inverted pyramid is an unknown and likely unknowable level of borrowing.

As we saw in the 2007-09 timeframe, given adverse circumstances, these spliced investments can unwind with very nasty consequences. And, even though much has been said and purportedly accomplished to improve the underpinnings of the world's economy, in fact, no significant action has been taken by regulators anywhere to reign in the amount of borrowing that can be utilized to speculate in derivative investment securities.

For the future and until policymakers become serious about regulating the potential for catastrophic risk in the investment universe, we should consider the overhanging threat posed by the potential for an implosion of an inverted pyramid of interconnected derivative securities that is supported by unfettered leverage as serious and meaningful and manage portfolio risk accordingly.

Managing risk prudently, of course, has always been Wealth Conservancy's philosophy, that is: to achieve the highest possible return for the lowest risk that is appropriate for each client account.

Commentary on the need for a Comprehensive Fiduciary Standard

Department of Labor regulations are scheduled to go into effect in the mid-April time frame that will require all investment advisors to adhere to a fiduciary standard when advising clients on retirement account investments. A fiduciary, such as Wealth Conservancy, is held to a standard that requires that only the client's (or customer's in the retail trade) interests are to be considered when investing or making investment recommendations whereas current ethical standards require only that a recommended investment be "a suitable investment" for the client. These are vastly different ethical standards.

In our opinion, an inherent conflict of interest always exists for those who do not hold themselves to the fiduciary standard. In effect, non-fiduciary advisors are constantly placed in the position of determining how much they will take advantage of a client and of the client's situation. The most honest of these advisors attempt to moderate their or their firm's greed, while the less ethical simply try to meet the minimum legal requirement.

Recently, the Institute for the Fiduciary Standard (IFFS) released the results of a study of the disclosures reported to the Securities and Exchange Commission that were provided by 135 Registered Investment Advisors (RIAs) and nine very large financial services firms in 2016. Of these firms, 76% of the RIAs and 100% of the largest firms reported that "a relationship material to their business that creates a material conflict of interest with their clients" exists in their business! Fifty six (56%) percent of the largest firms admitted to having been convicted or having pled guilty to a felony pertaining to their practices. Eighty nine (89%) have been found guilty by the Securities Exchange Commission (SEC) or Commodities Futures Trading Commission (CTFC) of being involved in ethics violations, while the same percentage ( 89%) have had a civil monetary penalty imposed. *

Of course, the percentage of these firms that have pled "nolo contendere" i.e., they do not admit wrong-doing but that they present no defense for their alleged fraudulent actions (and generally agree to pay a fine), very likely approaches 100%.

Moreover, although less affluent clients are by far the most frequently and egregiously victimized, high net worth clients are also routinely disadvantaged (but, interestingly, finding meaningful and up-to-date statistics on the extent of "high net worth" client victimization by large wealth management/brokerage firms is rather difficult.)

However, isn't it about time that all investors are protected by law and regulation against fraud and conflict of interest and that all advisors should be held to a reasonable standard of dealing exclusively in their clients' interest? And, not just for retirement accounts under the jurisdiction of the Department of Labor but for all client accounts. This is simple, straightforward honesty.

Clients can be certain that Wealth Conservancy has always and will always continue to adhere to the highest of fiduciary standards, regardless of the result of challenges to the DOL pending regulations.

* Clark at Large, by Bob Clark, November 2016 issue of the Investment Advisor magazine.

Updated on January 20, 2017.

Wealth Conservancy International, Inc., 7411 River Road, Fredericksburg, VA 22407
Tel: 540-548-3009 | Toll-free 1-800-515-1588
E-mail: wciicpb@comcast.net