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Financial Samurai 1Q2018 Investment Update And Outlook

Updated: 03/14/2021 by Financial Samurai 73 Comments

2018 investment outlook from Financial Samurai

This is the Financial Samurai 1Q2018 investment update and outlook.

Hopefully everyone got some laughs this April Fool’s! It’s always good to poke fun at yourself once in a while to stay grounded. Yes, Twitter is indeed like high school where there are gang ups, non-stop gossiping, and outbursts of hormonal rage. One of the main reasons why Disney decided to back out from their purchase of Twitter was due to the fear that all the hate would spill over and tarnish its reputation.

Anyway, I stand by my belief that if you are a happy person with a healthy dose of self-esteem, it’s hard to tell others to f off once you have f you money. Money simply magnifies who you already are. Let’s show empathy to the ones who dislike us the most.

For 2018 and beyond, I’ve decided to do things a little differently by taking away the absolute dollar amounts I invest. Given that there’s been so much rage against the middle class in expensive coastal cities, I don’t want the numbers to be a distraction. Only my family cares about how much we invest anyway.

Financial Samurai 1Q2018 Investment Update And Outlook

Stock Market Overview And Outlook

After rising as much as 7.22% in January, the Dow and S&P 500 closed down ~4% for after April 2. The initial ascent was unsustainable since such continued performance would lead to an annualized gain of over 100% for the year after a strong 20% in 2017.

S&P 500 One Year Chart 2018

Unfortunately, the government is no longer a tailwind, but a headwind with the start of trade wars with China and other countries. It’s now all about protecting special interest groups and asserting one’s dominance over others. It will be interesting to see if Trump can survive full-term if the stock market continues to falter.

Tech is out of favor at the moment after a huge data breach at Facebook, Uber’s self-driving car killing a woman in Arizona, another Tesla crash on autopilot with negative talks about Model 3 production, and Trump going after Amazon for not paying enough taxes (Financial Samurai pays more corporate income tax than Amazon).

With the S&P 500 down about 11% from its peak and having tested its bottom again in March, the market is trading at about ~16.8X 12-month forward estimated earnings. Prior to the selloff, the S&P 500 was trading at 18.2 times expected earnings, pricey compared to its 10-year average of 14.5. In December, the S&P 500’s forward PE reached as high as 18.9 before analysts began to increase their estimates for companies reporting their fourth-quarter results.

Therefore, even at ~16.8X forward P/E, the S&P 500 is not cheap compared to historical averages. However, if earnings grow by an estimated 18.4% over the next four quarters, you’ve got a P/E to Growth (PEG) ratio of less than 1X, which seems reasonable if the world can get along.

S&P 500 forward P/E 2018
Source: Thomson Reuters I/B/E/S
S&P 500 earnings estimate 2018
Source: Thomson Reuters I/B/E/S

The best way I see the stock market regaining its footing is by companies reporting solid 1Q2018 results in 2Q. We’ve been whiplashed around by news and government rhetoric. If the majority of companies in the S&P 500 can meet or beat earnings expectations, then the expectations for an 18.4% S&P 500 earnings growth estimate will become stronger. If this happens, confidence will return to the stock market since stocks trade on earnings fundamentals at the end of the day.

I deployed a fourth of my remaining house sale proceeds at the beginning of the year, another fourth in February after the meltdown, and another fourth at the end of March when we hit a “double bottom.” I invested the rest of my house proceeds + cash flow into the bond market, which we’ll talk about next.

Stock Market Outlook At Current Levels: 7/10. I estimate 10% further downside at most and 15% upside if everything falls into place. I always look at investments with a risk / reward ratio.

Bonds Market 1Q2018 Overview And Outlook

With fiscal stimulus and tax cuts, the market decided that such moves would be highly inflationary. Bonds sold off as a result, causing bond yields to rise and stocks to fall.

My line in the sand for the 10-year bond yield is 3% for 2018. It came close to breaching 3% when we got up to 2.94% on February 21. But yields have since come back down to around 2.73% with all the turmoil going on in the stock market.

Although the Aggregate Bond Market Index is down about 1.2% for the year, that’s better than being down 4% in the S&P 500. We might be in a situation this year of what asset classes loses us the least. But it’s too early to tell. Even if bonds end up down 2% for the year, you’re still up 0.75% if the yield is 2.75%.

US Bond Market Performance 1Q2018

I’m sticking with my belief that the 10-year bond yield does not breach 3% for 2018. Even if we do, it won’t be for very long (less than a couple weeks). In other words, the yield curve will continue to flatten if the Fed does not slow down its rate hikes, providing an ominous sign that a recession is coming.

Flattening yield curve 2018

Given the Fed isn’t stupid, I’m confident they will adjust their rate hike count and amount if the labor market weakens, inflation comes under expectations, and the stock market continues to correct.

I bought California muni bonds and some longer term treasury ETFs at the end of February after the 10-year yield broke 2.9%. A 3% muni bond yield is equivalent to a 4.3% gross yield if you have a 30% effective tax rate. A 4% gross yield has always been my post-work retirement target return.

Bond Market Outlook At Current Levels: 6/10. 1-2% downside, 3%-4% upside. When the 10-year yield was at 2.94%, I would give the bond market outlook a 8.5/10, but the yield has since come down.

Real Estate 1Q2018 Market Outlook

One of the good things about global uncertainty is that investors seek the security of bonds, thereby lowering bond yields. With the 10-year bond yield coming off its highs, the real estate market may not get squeezed as hard as it could. That said, we are still ~45 basis points higher than we were in December 2017, so debt servicing is more expensive.

Latest Mortgage Rates In 1Q2018
Mortgage rates are past their 5 year highs for 15Y and 5/1ARM

I continue to be very cautious about expensive coastal city real estate. Unless you are super bullish about your career prospects, have a massive liquidity event, have at least 30% of the value of the house you want to buy in cash (20% down, 10%+ cash buffer), or are starting a family plus at least one of the things I just mentioned, I would not be buying coastal city real estate, especially if you don’t plan to own the property for 10+ years.

See: It Feels A Lot Like 2007 Again: Reflections From The Previous Top Of The Market

Manhattan asking prices are dropping 2018
Pricing pressure generally starts at the top and works its way down. Beware.

The risk reward for leveraging up at current valuations is unwise for the average person. Rents are falling in places like New York City, San Francisco, Chicago and Honolulu. With more supply in Seattle coming online than any other time in the past, Seattle rents are also starting to soften.

Please read BURL: The Real Estate Investing Rule To Follow, if you haven’t done so already.

If earnings fundamentals are important to you, as they should be, the price you decide to pay for your property should be equivalent to the price from the record month MINUS the rental price change since that record time period. In other words, if you are planning to buy a 2-bedroom apartment in Honolulu this year, look up what the price of a comparable apartment was in January 2015 and subtract 25%. That price will give you a rough idea of where you should offer or counter offer.

Now is the time to be picky and negotiate, not be the foolish winner of a manic bidding war.

US rental market levels for 2018

As for non-coastal city markets, they’ve got further room to run due to lower valuations and stronger demographic trends. That said, each market is different, and eventually, their waves will also crest. Focus on demographics because some places like Denver and Dallas have gone bonkers.

The stock market should give real estate investors some insight into the future. Look at sectors that are heavy in the city and state you want to buy and see how they are doing. Stocks reflect future earnings, and if earnings are at risk, so is job growth, wages, and housing demand.

Geo-arbitrage within the United States is going to be a multi-decade trend, which is why I’m investing in the heartland of America.

Housing Outlook For Expensive Coastal Cities: 3/10

Housing Outlook For Non-Coastal Cities: 7.5/10

Alternative Investments 1Q2018 Outlook

Even though many investments are struggling in 2018 so far, there’s one investment that has struggled the most: cryptocurrencies! It was absolute carnage in the space. Names like Bitcoin, Ethereum, and Ripple are all down 50%+ for the quarter, so don’t feel bad if you’re down single digits in the stock market.

The collapse of cryptos is a great reminder to keep your alternative investment exposure limited to what you can afford to lose. For me, I keep all alternative exposure to no more than 10% of net worth.

One interesting note, I did have a long conversation about cryptos with a multi-billionaire a couple weeks ago who believes the crypto space will be completed diluted with an endless supply of new cryptos, partially because his company will easily enable all his customers to create their own.

Bitcoin collapses like the NASDAQ 2000 Tech Bubble

Elsewhere, I was surprised to get a $2,623 payout from real estate crowdfunding in February, since I’ve been modeling only ~$9,600 for the entire year in my 2018-2019 passive income estimates. I haven’t received any notification yet for March as it usually takes a couple weeks after month end to update, but I’ll update the chart once the numbers come out.

At the moment, investing $300,000 in real estate crowdfunding in December 2017 looks like the right choice. I’ve got a total of 17 different investments, the large majority of which I like. But it will take years to find out how well they do given all my investments are equity deals.

With the sale of my SF rental house and the sale of my private gin investment to Campari in 2017, I tried to keep my income as low as possible since the sales shoved me into a higher marginal tax rate before expenses. For 2018, I don’t expect to see another large windfall, hence I’m more open to earning more this year, especially since taxes have declined.

RealtyShares Dashboard - 1Q2018
I’ll update this chart once March figures hit

Risk Control Is Paramount In 1Q2018

You must go through your net worth asset allocation and do an honest assessment of your risk exposure. Do not be caught with your pants down at a highway rest stop. Predators come out. So long as you know how your money is being allocated and have a plan for what to do in different scenarios, you will go through life with much less financial stress.

As for me, I still feel good reducing ~$815,000 (mortgage) worth of risk exposure in 2017 and diversifying the house proceeds into various other investments. I’m actually considering selling my remaining SF rental given the last piece of avoidable stress in my life is dealing with a power-tripping HOA that has hired a terrible property manager as its minion. They hate landlords.

After verifying with my Personal Capital dashboard, I’ve got about $295,717 in cash left. It’s a little deceiving because $185,000 of the balance is from a CD which is coming due this summerl. The CD was paying 3%, and I’m sad to see it go. At the same time, given asset prices are finally pulling back and interest rates have also moved up, the timing for reinvesting the proceeds is better.

Further, I’ve got to pay tens of thousands of dollars in extra taxes to support this great country of ours! Once I pay my tax bill I’m going to come up with a cash accumulation + investment game plan once again. This year is too tricky not to be on point.

Financial Samurai cash balance 1Q2018
Cash balance history since home sale

I’d love to hear your thoughts about the stock market, bond market, and real estate market. Would you be happy with a 3% – 4% return in 2018 given all that’s gone on so far? Please invest at your own risk. Every investment decision you make is yours to keep. Related: Things To Do Before Making A Single Investment

Financial Samurai 1Q2018 Investment Review And Outlook is a Financial Samurai original. Check out the Top Financial Products page to help you achieve financial freedom.

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Filed Under: Investments

Author Bio: I started Financial Samurai in 2009 to help people achieve financial freedom sooner. Financial Samurai is now one of the largest independently run personal finance sites with about one million visitors a month.

I spent 13 years working at Goldman Sachs and Credit Suisse. In 1999, I earned my BA from William & Mary and in 2006, I received my MBA from UC Berkeley.

In 2012, I left banking after negotiating a severance package worth over five years of living expenses. Today, I enjoy being a stay-at-home dad to two young children, playing tennis, and writing.

Order a hardcopy of my new WSJ bestselling book, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. Not only will you build more wealth by reading my book, you’ll also make better choices when faced with some of life’s biggest decisions.

Current Recommendations:

1) Check out Fundrise, my favorite real estate investing platform. I’ve personally invested $810,000 in private real estate to take advantage of lower valuations and higher cap rates in the Sunbelt. Roughly $160,000 of my annual passive income comes from real estate. And passive income is the key to being free.

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Comments

  1. emcee@InvestingParExcellence says

    April 16, 2018 at 2:56 pm

    Hi, As for investing in stocks, my personal approach is to take the guesswork out of my investing decisions. My investments are mostly in stocks but I keep ample cash for both rainy-day needs and as dry powder. 1Q 2018 was my first such opportunity (after a long while) to deploy some dry powder into stocks. Stocks went down by 10% so I invested 10% of my dry powder in it. I try not to worry where the market might go next. If it drops by another 10%, I will have more cash to deploy. If it recovers, fine. I will be able to replenish my dry powder then. This strategy does not work for everybody, I realize. I tend to be more risk tolerant than others. And I also have weathered multiple bear markets and as a result I am perhaps more sanguine than others. It had worked out well for me over the years.

    By the way, you mentioned Dallas as one of those middle markets that has gone bonkers! North Dallas suburbs (where I live) have appreciated in last few years but nowhere close to sellers market yet. In fact, Zillow rates Plano and Frisco suburban cities as “cold” and “cool” today.

    Reply
  2. GEM says

    April 15, 2018 at 9:01 am

    Thanks for this… it’s great.

    I am less financially technical than you…can you help?

    I live in San Francisco…sold my house last year and been renting since. I hated the home repairs/upkeep, property taxes, the high mortgage payment and the small space of my last house (2.05M and I had put 20% down so mortgage was 1.6M).

    Now I have been renting for a year and hate my place even more… because I was stingy on budget (in a California kinda way) … what I am getting for $4680 a month is not acceptable. I really need to like where I live, i.e. be comfortable in my space, for any price point in San Francisco.

    Rental on a place I like would be $5500-$6000 a month, which seems like such a waste, so….

    I’m thinking about buying again… in an “emerging area” on the south side of the city, so I can get a house I am comfortable in and excited about ….and not pay at/above $2M.

    I found a 1.5M gem (which is the upper end price wise for this area but less than the new SF home price median of 1.6M).

    I have 2.7M net worth right now (and spend 150K annually so I am OK) and am not worried about job security as the job market in bio is very healthy. I would put down 750K, so 50%, as that would allow me to get my mortgage down low to less than 4K/month which I can stomach. Caveats are I plan to leave San Francisco sometime between 3-7 years from now…. so I’d sell my house at that time.

    I do not have to MAKE money on the house (beyond my cumulative equity) but I do not want to LOSE money on the sale…

    So thinking about all of the guidance you provided about only buying if you are bullish on your career, have a massive liquidity event (what does his mean?), will put down >30%… and something about the rental market that I didn’t understand…. what is your advise on me jumping back into the market and purchasing this home where the area is a little bit questionable … but I love the house and am excited I could finally get comfortable in it?

    Thank you Sam et al!

    Reply
  3. DK says

    April 14, 2018 at 6:18 am

    Sam thanks for insights. What are your thoughts about shorting Real Estate?

    Reply
  4. Ilya says

    April 9, 2018 at 6:10 pm

    Sorry, I misunderstood. I am short.

    Reply
  5. Ilya Eckstein says

    April 6, 2018 at 9:44 pm

    Sam, thanks for the insights.

    But I am not sure your real estate logic is bulletproof. Everything you are saying about the SF Bay Area market was just as true a year ago. Yet home prices in Silicon Valley rose a whopping 22% over the last year! So, at the very least, buying a year ago would have been a terrific investment, wouldn’t it? At the same time, with the resurgence of tech IPOs this year and next, and the growing pervasiveness of tech in all industries, there is every reason to believe the Tech jobs – and therefore home values – will be just fine in the Bay Area for years to come.

    What am I missing?

    Reply
    • Financial Samurai says

      April 7, 2018 at 5:48 am

      If you can lend me your Time Machine, I’ll give you everything I have! :)

      It’s much more helpful to look forward. Big area is strong, but there are clear signs if you look at rent prices. The price appreciation is unsustainable.

      And I saw the latest first quarter numbers for the median home price. It might be due to mix, or one last hurrah. Those sales are mainly reflections before the stock market correction as it takes 45-60 days on average to close. But no doubt there is still a lot of demand and prices are strong.

      Are you long? I’d happily take a $700K appreciation in equity + any appreciation in Lake Tahoe prices if the 22% is true!

      Reply
      • Ilya says

        April 9, 2018 at 5:20 pm

        I don’t know if I am “long” enough from a pure investment standpoint, but figuring out if I’m long enough to become a first-time homeowner (albeit maybe a short term-oriented one).

        Reply
        • Financial Samurai says

          April 9, 2018 at 5:38 pm

          Don’t get it. Are you currently renting your place in the Bay Area or did you buy? If you bought, you’re long! If you rent, you’re short.

          Reply
      • Ilya says

        April 9, 2018 at 6:18 pm

        Per Zillow, e.g., in Mountain View the yearly appreciation was 26.3%!

        Reply
  6. Ilya Eckstein says

    April 6, 2018 at 1:28 am

    Sam, thanks for the insights.

    But I am not sure your real estate logic is bulletproof. Everything you are saying about the SF Bay Area market was just as true a year ago. Yet home prices in Silicon Valley rose a whopping 22% over the last year! So, at the very least, buying a year ago would have been a terrific investment, wouldn’t it? At the same time, with the resurgence of tech IPOs this year and next, and the growing pervasiveness of tech in all industries, there is every reason to believe the Tech jobs – and therefore home valuesbe- will be just fine in the Bay Area for years to come.

    What am I missing?

    Reply
  7. dunny says

    April 5, 2018 at 9:44 pm

    Great analysis, Sam. I will be rereading several times and trying to assess the impact on markets, interest rates, and my investments.

    I don’t jump in and out of the market. Doesn’t matter when you buy stocks as long as you ride a stock up (and sell if it goes down, i.e. stop loss). You don’t need to buy at the bottom or sell at the top to make a very good return. You can do this stock by stock or sector by sector. But not if the entire market goes down. Then you hold on and ride it back up.

    We are in a (slow) rising rate environment, so I would not be investing in bonds or equivalents. The time to buy bonds is in a declining rate environment. Unless you plan to hold to maturity. My preference would be dividend stocks with growth that would at least have capital gain plus dividends.

    Okay to hold cash because it does not go up and down with interest rates and it can soften the effect of a correction. Bonds don’t always do that. In fact, they never have for me. I gave up on a balanced portfolio and asset allocation decades ago.

    Not very sophisticated, but that’s what I do.

    Reply
    • Financial Samurai says

      April 6, 2018 at 7:05 pm

      I think you’ll be surprised with the bond market. Rates have been on a downtrend for 30+ years. Perhaps now they will finally go up a lot, but I doubt it.

      Right now, your dividend stocks have negative appreciate + dividends. It’s a trick market right now. Hang tight!

      Reply
      • dunny says

        April 6, 2018 at 7:23 pm

        Back when interest rates were normally over 10%, my rule of thumb was go 5 year term mortgage renewals if the rate was under 10% and 5 year with CDs if the rate was above 10%. Will watch bond rates with interest. Right now, my stock portfolio is up 5.55% (as of yesterday). My stocks pay small dividends and have growth so I am good there. I have FX working for me too (CAD keeps sinking and I have more than 50% in USD). I am hoping interest rates stay low because I have a lot of mortgage debt, and with rates low, it boosts the stockstoo. Right now, everything is working for me — low interest rates, low CAD. The low CAD is a killer on travel though. If I had your NW and earning capacity, I would be doing the same — big bond portfolio. Based on valuation of my pensions, I sort have the equivalent of that (according to your valuation method). Keep writing, you are the best on the net.

        Reply
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