The month of May was not kind to equity markets as the S&P 500 dropped 6%. International stocks were down for the month, too. The EAFE lost 5% while Emerging Markets were down 7%. Sell in May and go away? We don’t think so. The timing of the drop is luck more than anything else. Fingers have been pointed at the so-called trade war, various tweets, and the ever-present market “jitters”. All of these issues (real or imagined) have been part of the investing environment for over a year.
The truth is that no one really knows why the market moves one way or the other on a day-to-day basis. Bank of America Merrill Lynch’s Global Fund Manager Survey listed the following fears as the biggest tail risks going back to 2011: central bank policy mistakes, political populism, a Chinese hard landing, geopolitical crisis, a different Chinese hard landing, the US fiscal cliff, and EU sovereign debt funding. Despite that, the S&P 500 is up 14% over the last ten years, annualized, and almost 10%, annualized, over the last five years.
Most investors, and certainly all our clients, know that market timing (i.e. trying to move in and out of the stock market based on a prediction of the future) is a bad idea. I recently read an article with some data that really illustrates the risk:
Over the last 92 years (1927-2018), the S&P 500 has returned 10.1%/year
If we remove the best 92 months over that period, the return of the S&P 500 would be almost exactly 0% (0.01% to be precise)
So, if an investor was invested on average 11 out of every 12 months, but happened to miss that one best month, they got no return…while the buy and hold investor got over 10% per year
The numbers were very similar in the international markets as well, with almost all the return coming in short bursts
We’ve recently had what will likely be one of those top 92 months. In the month of January 2019, the S&P 500 returned approximately 8%. Yet according to Morningstar, there were $83B of net outflows from mutual funds and ETFs in December 2018, making it the worst month of net flows since the financial crisis in October 2008. So right before one of those “best” months…and right after the worst quarter since the financial crisis… money was flooding into cash. Ugh!
2019 is off to a hot start as the S&P 500 gained 13.7%. Will the market keep up this pace for the rest of the year? It’s unlikely, but the “pace” is also a bit misleading. We have not yet made up the ground lost in last quarter’s sell-off. This is setting up to be a good calendar year, but the market is at about the same place it was six months ago. On Christmas Eve we were on the cusp of a bear market. Today, the media is back to searching for the downside of an upward trend.
It has been 10 years since the bottom of the Great Financial Crisis. The S&P 500 gained over 400%, including dividends, for an annualized return of 17.6%. The numbers don’t tell the whole story. While the total return sounds great, the first three years of that rally were spent just getting back to zero. The S&P 500 had lost half its value and needed a return of over 100% just to recover. A moderate portfolio would have recovered in about half the time, but the early years of the rally were not easy for anyone, regardless of asset allocation. Negativity was the baseline.
This Commentary Brought to You in Part by Macaroni and Cheese
The latest earnings report for Kraft Heinz was a shocker. Operating results were flat, there was a huge impairment ($15.4 billion) of goodwill, and the dividend was cut by 40%. On top of it all, the SEC is investigating accounting irregularities. The most surprising piece of the story is that Warren Buffett’s Berkshire Hathaway owns a big (26.7%) chunk of Kraft Heinz. This sort of thing isn’t supposed to happen under Uncle Warren’s watchful eye. What happened?
“It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.”
Mark Twain’s famous quote may provide all the explanation needed. America’s taste for processed cheese and ketchup just isn’t what it used to be, but investors didn’t catch on (revenues had even been flat for a couple of years). Beyond the numbers, this is also a marking to market of the Kraft Heinz brand. For a deeper dive, I suggest Aswath Damodaran’s write-up. He’s a professor of finance at NYU and has a great way of unwrapping stories like this.
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.