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Bogue Asset Management’s Quarterly Investment Letter In this quarters commentary, I discuss how volatility returned to the markets and how it should be viewed as a return to the norm than an anomaly.  Also I do not believe that core bonds will be a safe haven in this environment..........[See More]


How your advisor is compensated does matter.  Lately there has been a blurring of the lines with the use of the term “Fee-Based” to describe how one is compensated.  I’ll tell you why Fee-Based is not Fee-Only and the difference can be substantial: [See More]






First Quarter 2018 Key Takeaways


Volatility returned to the financial markets in the first quarter, for the first time in a while. Stocks surged out of the gates in January, then corrected sharply, before rebounding into mid-March, clawing back much of their losses. They then dipped again into quarter-end, buffeted by a potential trade war and a Facebook data scandal. When the dust settled, large caps ended down 0.8% for the quarter.


Developed international stocks also got off to a strong start to the year, before suffering similar losses to U.S. stocks during the sharp correction in early February. They made up ground relative to U.S. stocks in March and ended the quarter down 1%. 


European stocks (unhedged) lost a bit more than 1%. This could be due to a variety of reasons from European politics to a lower exposure to technology. My views have not changed and I am maintaining a modest overweight to Europe.


Emerging-market stocks held true to their higher-volatility reputation. They shot up 11% to start the year, fell 12% during the mid-quarter correction, and then once again outgained U.S. and international stocks to finish the quarter with a 2.5% return. My portfolios overweight to emerging-market stocks added to returns as they outperformed U.S. stocks for the period.


Core bonds did not play their typical safe-haven role in the first quarter. They posted losses during the sharp stock market correction in February and delivered a 1.5% loss for the quarter overall, as Treasury yields rose across the maturity curve. 

Absolute-return-oriented and actively managed fixed-income funds, in addition to floating-rate loan funds, outperformed the core bond index for the period. This has been the case over the trailing three- and five-year periods as well.  I continue to expect these positions to outperform over the next several years, particularly if interest rates continue to rise. 


Finally, the performance of the liquid alternative strategies was mixed. Lower-risk arbitrage strategy funds were flat during the market correction and slightly positive for the entire quarter, beating both bonds and stocks. Trend-following managed futures funds started the year with very strong returns but gave them back and then some during the February market correction. I expect these positions to be volatile, but my confidence remains high that these disciplined trend-following strategies will be beneficial to client portfolios over full market cycles.


At the end of last year, by some measures U.S. stock market volatility was the lowest it had ever been in 90 years of market history. While the 10% market correction this year was short-lived, it provided a reality check for equity investors. However, the global economy still looks solid in the near term. And looking ahead, I have positioned portfolios for further volatility and likely lower equity returns as the markets ride out what is already a longer-than-usual economic cycle.  

First Quarter 2018 Investment Commentary Market and Portfolio Recap

Needless to say, it was a bumpy start to the year for financial markets, something I would suggest getting used to in the months and years ahead. After years of record-low volatility, the 10% market correction this quarter was a reality check for investors: Stocks can go down as well as up.


Equity investors should understand that stock market declines of 10% or more are normal. They 


have happened in over half of all calendar years since 1950. In exchange for their higher long-term expected returns, you must be willing and able to ride through these inevitable periods of decline.


Portfolio Attribution

In what was a difficult quarter for most asset classes, investments in emerging-market stocks benefited portfolio returns.


The active fixed-income positioning also helped to support portfolios during a period when core bonds failed to play their typical safe-haven role. Absolute-return-oriented and flexible bond funds were in positive territory for the quarter, and floating-rate loan funds gained around 1%. Arbitrage strategies also provided some downside ballast versus stocks and core bonds.


Among the portfolio detractors for the quarter were the trend-following managed futures funds, which started the year with very strong returns but gave them back and then some during the February market correction.


Market and Portfolio Outlook

I have two primary observations about the quarterís rocky ride. First, the declines witnessed serve as a good reminder that markets do not exclusively go up. Until the recent drop, the S&P 500 had rallied for more than 400 days without registering even a 3% decline from its high. That was the longest streak in 90 years of market history. So, from that perspective, the return of market volatility is a return to normal market form. I believe investors should be prepared for continued volatility rather than expect things will revert back to the unnaturally smooth markets we experienced in 2017.


My second observation is that despite the dramatic news headlines and market volatility that might 


suggest otherwise, the global macroeconomic and corporate earnings growth outlook has not materially changed or deteriorated from what it was at the start of the year. In fact, the economic news that triggered the recent selloff was not a report of economic weakness but one that suggested the economy might be getting a bit too strong, with a tight labor market finally translating into higher wage growth and broader inflationary pressures. Fundamentally, even after the correction, the U.S. and global economies still look solid. Global growth may no longer be accelerating, but it remains at above-trend levels and the likelihood of a recession over the next year or so still appears low (absent a macro/geopolitical shock).


The U.S. economy is getting later, if not late, in its cycle. We are experiencing the unwinding of an unprecedented period of global monetary policy influence, and geopolitical tensions fill the headlines, the latest being the potential for a trade war between the United States and China.


It is not in my nature to speculate on whether any of these factors will trigger more market volatility, and what their impact will be if and when markets react. However, it is in my nature to ensure I have properly assessed and managed risk in my client portfolios across a wide range of shorter-term outcomes, while positioning them to capture longer-term returns. With very little portfolio protection offered by core bonds in this flat to rising interest rate environment (i.e., returns more in line with this quarters losses), I continue to look to my positions in alternative strategies to behave more favorably during sustained equity market declines and generate returns independent of stock and bond markets.


I also remain defensively positioned in equity risk allocation and tilted in favor of more attractive foreign market valuations. While not table-pounding in an absolute-return sense, the outcomes I see for European and emerging-market stocks continue to be more relatively attractive than U.S. stocks. 


My analysis suggests the positive economic outlook has already been discounted to a meaningful degree in current U.S. stock market prices. So while the economy is strong, the stock market has been reflecting this for a while. The valuation of the S&P 500 is well above my estimate of its fair-value range on a normalized (longer-term) basis. As the valuation multiple comes down, it will be a significant drag on the total return of the market index over my five-year investment horizon, regardless of the earnings outlook.


The Best Defense

As I reflect on the volatility levels we have witnessed so far this year, it is worth reiterating why I emphasize a five-year or longer time horizon as the basis for my expected-returns analysis. It is over those longer-term periods that valuation (i.e., what you pay for an investment relative to its future cash flows) is the most important predictor of returns. Over the shorter term, markets are driven by innumerable and often random factors (i.e., noise) that are impossible to consistently predict (although that doesnít stop lots of people from trying). 


There are a lot of paths financial markets and the economy can take to reach my base case scenario destination. And there is a wide range of reasonably likely outcomes around that base case. Simply put: markets and economies are unpredictable. But when it comes to the investment world, we are often our own worst enemy. We fall prey to performance-chasing, our natural inclination to do something, and other behaviors that may have helped our ancestors, but hurt us as investors. The best defense is a sound, fundamentally grounded investment process like mine that you can have the confidence in to be able to stick with for the long term.



Thank you for your continued confidence and trust.

Jeff  (04/10/18)



Certain material in this work is proprietary to and copyrighted by Litman Gregory Analytics and is used by Bogue Asset Management LLC with permission.  Reproduction or distribution of this material is prohibited and all rights are reserved.