The S&P 500 seemed destined for bear territory (a fall of at least 20%) at the end of last year. It was down 17% when the US government shut down on Saturday December 22nd. On Monday, the 24th, a frenzied half-day of trading left the market down more than 19% from its high. The bull run was all but over. Bears were breaking out the honey and vying for gloomiest forecast on TV. After all, there was a government shutdown, continued China trade disputes, and confidence in the Federal Reserve was shaken.
Just as the bear was about to move in, the door was slammed in its face. The market ignored pundit opinions and rallied hard. The S&P 500 was up over 10% during the shutdown, popping up over 15% from the December low through the end of January.
Hail to the King – Cash was king in 2018, up 1.87%. Chances are your savings account outperformed your portfolio this year, as 2018 was a highly unusual year where virtually every other broad asset class lost money. Keep in mind that inflation probably outperformed your savings account, so cash is still not a good long-term protector of your capital. Speaking of cash, have you shopped around for a higher-yielding (about 2%+) savings account?
December ended with a Bear Kiss. The S&P 500 dropped 19.4% from its all-time high. While not officially a bear market drop of 20%, watching the market’s daily moves (not recommended) left many investors wiping off bear slobber. This was followed by a sizable post-Christmas rally. If you were asleep all year and just woke up to look at 2018’s numbers, you might think it was a sleepy year for US Large Cap stocks (down 4.4%), too. Day-to-day, the markets were much noisier. The S&P 500 dropped over 10% twice in 2018, once in January/February (followed by a 15% rally) and once from September through Christmas Eve. Domestic Small Cap stocks dropped 10.3%. Taxable bonds ended the year flat while Municipal bonds were slightly up. International anything had a rough year. International bonds were down 0.9%, Developed International stocks dropped 13.8%, and Emerging Markets were off 14.6%. Real Estate was down 4%.
The S&P 500 finished November with the largest weekly gain in 6 years. What does this tell us about the market? Maybe it tells us that the October sell-off was an overreaction. More likely it tells us the same thing the October sell-off told us: No one can predict short-term market movements. Further, ascribing a rationale to past market movements hinders our ability to make sound investment decisions going forward.
If we assume a past cause and effect relationship, we will be tempted to expect the same going forward. This is ridiculous, of course. You could conclude any number of relationships out of the recent market movements. Buy on dips of 10%? Sell the hawkish Fed and buy dovish remarks? Trade on trade negotiation news or auto plant closings (or possible openings if BMW is to be believed)?
Our message to remain true to your financial plan and focus on long-term goals rather than today’s headlines is a familiar one. Cynics may wonder why our commentary is so plain and treats common sense as not-so-common. We don’t forecast GDP. We’re not trading in reaction to Tweets. You don’t see sector rotation, charting, or Greek letters in our communications.
It’s tough to write in reaction to short term market movements as each client’s situation is different. We truly design every client’s portfolio according to their individual needs. We are not trading wholesale in and out of positions. We do not have model portfolios. When we do make changes to asset allocation, they are thoughtful (not reactionary) and executed with an eye to controlling what we can control (taxes and fees) for each and every portfolio. Our commentary is intentionally broad as we have a diverse set of clients.
We are often asked, particularly by prospects, for investment ideas – something outside the box that goes up like a stock and protects on the downside. All they want is 10% annual returns with no negative years. No such thing exists or we’d have been trick or treating in St. Bart’s last week.
Right now (when the market is volatile) is when the real investment gains are made. Ok, maybe we won’t see actual gains, but part of long-term investment success is avoiding permanent losses. For many investors this occurs during these volatile times when they panic and deviate from their investment plans. Success can come just from sticking to your financial plan (I hope you have one). It’s not sexy. You don’t need a star manager, a room full of PhDs, or a high frequency trading algorithm. I have yet to come across a financial plan that says sell every time the market dips 10%. On the other hand, I’ve heard plenty of folks who are sitting on cash say that they will put it to work as soon as the market doesn’t look so expensive, you know, if it drops 10% or so. Not many follow through on that intention, saying that now that the market has dipped, the market is too weak to invest in. They remind me of the Yogi Berra “Nobody eats there anymore, it’s too crowded” quote.
The S&P 500 is up 10% year to date. Does it feel like it? While the US stock market is having a strong year and the economy flexes its muscles, long-term investors may be feeling left behind. Why? Domestic stocks are up double digits, but a portfolio of 60% stocks / 40% bonds is only up 5.6%. A more diverse portfolio might only be up 3%. Bonds are flat or slightly down on the year and international stocks are down and being stomped by the strong dollar. Diversification that saved investors from the worst of the financial crisis now weighs on performance.
Why Invest Internationally At All?
Despite the short-term (now intermediate-term, really) underperformance of international stocks, consider:
The United States makes up about half of the market capitalization of the equities in the MSCI All Country World Index and about a third of the global bond market.
Access to international stocks and bonds is getting easier and cheaper.
The global opportunity set is growing as more countries open themselves to foreign investors (China A shares, Saudi Arabia) in both equity and bond markets.
The strong US Dollar has been a headwind for both developed and emerging market equities.
Foreign Central Banks are still holding rates incredibly low as they lag behind the US in recovering from the financial crisis.
Valuations for developed and emerging markets are below their 25-year average while US valuations are higher than their average.
The Queen of Soul, Aretha Franklin, recently passed away with an $80 million estate… and no will. The news follows in the footsteps of other celebrities (Prince comes to mind) who never found the time to complete their financial plan. Most of our clients aren’t cashing royalty checks, but the lesson is still the same. In the financial planning world, investing steals the spotlight, but the other aspects of financial planning are what make the show run smoothly.
I have a bold prediction to make. Yes, I know I talk all time about how Fairway isn’t in the prediction business and that basing any long-term financial decision on a forward-looking prediction is a fool’s game, but I’m going to do it anyway:
I predict that the 10-year return on the S&P 500 is going to rise substantially in the next several quarters. Wow, that sounds bold…is Matt really saying that he thinks the market is going to rise big-time the rest of this year? Of course I’m not saying that! My honest answer is I have no idea what the market will do in the next few quarters.
It’s July and in Cleveland the sun is finally out. The summer sun brings with it the potential for sunburn. Sunscreen is essential to avoid the pain and potential long-term damage from getting burned, but when it works we don’t really notice its positive effect. Having bonds in a portfolio Continue Reading →
One of my favorite investment reads is The Route to Performance by Oaktree Capital’s Howard Marks. Marks starts by disputing the argument that more risk means more return, “If you want to be in the top 5% of money managers, you have to be willing to be in the bottom 5%, too.” Instead of outperformance, this philosophy can lead to a “long-term record which is characterized by volatility and mediocrity.” He then recalled a meeting he had with a pension plan director:
“We have never had a year below the 47th percentile over that period or, until 1990, above the 27th percentile. As a result, we are in the fourth percentile for the fourteen year period as a whole.”
Instead of taking big risks, the pension plan director aimed for consistent performance, resulting in stellar long-term performance as peers self-destructed.
The Howard Marks note was written in 1990, but is still relevant today. The SPIVA Persistence Scorecard further debunks the idea of an investment strategy placing in the top 10 (or even 50!) percent of its peer group every year. Investment manager selection isn’t about picking what fund will outperform in a calendar year, it’s about finding consistent performance. For most asset classes, that means buying the index.