09 Jul Market Update – Summer 2018
Not much has changed since our last update in the spring. The US stock market continues to grind in a sideways movement with no major gains or losses (as shown below by the S&P 500). This is not entirely unexpected after a solid year of gains in 2017. We still expect stocks to move higher at some point this year. On the surface, things look rough with the political situation. However, the underlying US economy continues to show strength which gives us confidence that markets can continue higher before seeing any meaningful pullback. Most major pullbacks occur during times of economic recessions.
On the other hand, bond markets are not having a good year with losses around -2% for most major bond indexes. This is due to the rise of interest rates. The Federal Reserve has been hiking interest rates for the last couple years due to the strong US economy. When interest rates are rising the value of bond prices drops. The good news is that the drop in values is not permanent and going forward, investors will be receiving higher interest payments. This is welcome news as interest rates have been at historical lows for the past decade.
It is important to always remember that any market, whether it is stocks, bonds, gold, real estate, etc.. does not go up in a straight line. Markets are never linear and can go up, down, or sideways at any point for any reason. This is why diversification is the most important factor for successful investing overtime.
Who would ever think that stocks would be outperforming bonds this year when bonds are supposed to be the safer investment, especially with all the political headlines? This goes to show why it is critical to cancel out the noise and focus on what truly matters. What truly matters is providing our clients with diversified stable portfolios that have the probability of succeeding overtime. For us to do this we must be diversified, patient, and focus on what is happening under the surface.
So why doesn’t everyone diversify?
Because diversifying means there will always be an asset class beating you. Today, that asset class is U.S. equities and the fear of missing out (FOMO) on further gains is palpable.
Over the past seven years, each of the following asset classes have all massively trailed U.S. equities: International bonds, U.S. investment grade bonds, U.S. Treasuries, Asia-Pacific stocks, European stocks, and Emerging Market stocks.
Does that mean investors should abandon diversification and succumb to FOMO, putting 100% of their portfolio in the S&P 500?
- Only if they are 100% sure that the next seven years will look exactly like the past seven (unlikely, as the S&P 500 has outperformed the MSCI World ex-US Index in just over 50% of calendar years, little better than a coin flip).
- Only if they can handle significantly higher volatility (since 2012, the S&P 500 has an annualized volatility of 13% vs. 6% for the AOM moderate allocation ETF – and this has been among the lowest volatility periods in history for U.S. equities).
- Only if they can handle much higher drawdowns (the S&P 500 lost 37% in 2008 vs. 10% loss for a 40/60 allocation to US stocks/bonds).
Of course, no one can be sure of what will happen over the next seven years and few can handle higher volatility/drawdowns than their risk tolerance suggests. Source- pensionpartners.com
As always, we will continue to do our best of managing portfolios that will help reach your goals with the least amount of risk and volatility.