AS THE THIRD QUARTER ENDED, A NUMBER OF ASSET CLASSES AND MARKETS CLOSED AT OR NEAR THEIR ALL-TIME HIGHS. THE S&P 500 HAD ITS BEST QUARTER IN ALMOST FIVE YEARS, FINISHING LESS THAN 1 PERCENT FROM ITS ALL-TIME HIGH.
EQUITIES. While the broad U.S. Stock market rallied strong, gaining 7.12 percent, the Aggregate U.S. Bond Market remained fairly neutral, inching up only 0.02 percent. Internationally developed markets (Europe, Japan, Canada) were up marginally 1.31 percent for the period. Emerging Markets continued their slide, down 1.09 percent for the quarter and down over 7 percent for the year. A globally diversified portfolio of 50/50 stocks/bonds earned gained 2.43 percent for the quarter, and up 2.82 percent on a year to date basis.
On the large cap side, growth stocks continued to outpace value 9.17 to 7.42 percent. Large cap stocks also outpaced small cap stocks 7.42 to 3.58 percent.
Another excellent period of GDP growth emerged, up 3.04 percent on a Year over Year (YoY), making it now nine consecutive quarters of accelerating growth. However, entering the second longest period of economic expansion in U.S. history, markets were promptly met with volatility.
October quickly turned negative as company earnings began retreating and downward future guidance started to come in. Technology bellwethers such as Amazon and Google missed both sales and earnings per share estimates, the latter blaming ongoing margin pressures. Within a few weeks all of the strong Q3 market gains, and then some, were wiped out. The tech-heavy NASDAQ fell 9 percent and both the S&P500 and MSCI Internationally Developed Indices fell more than 7 percent.
FIXED INCOME. The Federal Reserve decided in September to hike the federal funds rate by 25 basis points (0.25 percent), their seventh hike in two years. This hike was again widely anticipated. The new Fed Chairman, Jerome Powell, has been transparent about their intentions. Given the continued strong economic trends, a December rate hike is quite likely to happen as well.
ALTERNATIVES. Looking over other investment categories, the US REIT index held steady, adding to its second quarter rebound, up 0.72 percent for the period. The Bloomberg Commodity Index eked out a small gain, up 0.40 percent for the period, once again the small net change masked the volatility underneath the index. Oil continued its upward climb, up 5.21 percent at one end of the spectrum with Nickel, Coffee and Sugar all down more than 13 percent for the quarter.
LOOKING FORWARD. The tax and regulatory reform that provided a substantial benefit to earnings in 2018 will soon be built into “base” comparisons going forward. When it comes to company earnings, “better or worse matters more than good or bad”, rate of change on the margin is where volatility originates. Earnings growth rates, which were 27 percent in the first quarter, have slowed to 19 percent in the third quarter and are expected to slow even further down to 8 or 9 percent as we move into 2019 and the more challenging “baseline” comparisons as noted above.
The stock market has clearly entered a more volatile phase with equity valuations reaching highly extended levels. This should not be much of a surprise as interest rates have moved higher, worries about global growth having peaked plus trade concerns, as well as the potential impact of Midterm elections held just this week. In addition, with unemployment now below 4 percent, wage pressures and inflation also loom. A potential offset is that we’re entering what has historically been a strong seasonal period for the markets (November through January).
There is a valid concern that the business cycle is aged, retracing its usual late cycle path and signaling a possible recession right around the corner.
MIDTERM ELECTIONS. Leading up to last Tuesday, a lot of consternation and opinions were expressed over which party would control the House or Senate or both. So what do electoral results mean for the markets? Interesting enough as outlined in the attached article, both parties governed over periods of significant market growth and significant market declines. There does not appear to be a pattern of stronger returns when any specific party is in control of congress.
INVESTING PHILOSOPHY. The path to success in many areas of life is paved with continual hard work, intense activity, and a day-to-day focus on results. However, for many investors who adopt this approach to managing their wealth, that wisdom can be turned upside down.
The Chinese philosophy of Taoism has a phrase for this: “wei wu-wei.” In English, this translates as “do without doing.” It means that in some areas of life, such as investing, greater activity does not necessarily translate into better results.
This doesn’t mean that we should always do nothing. In fact, insights from financial science suggest you should direct your investment efforts to the things you can control. These include taking account of your own preferences and sensitivities when choosing investment strategies, diversifying your allocation to moderate the ups and downs, being mindful of the impact of fees, and exercising discipline when emotions threaten to blow you off course.
Successful investing requires taking actions that can have a positive impact on the outcome. For instance, to maintain their desired asset allocation, investors should regularly rebalance their portfolio by reallocating money away from strongly performing assets.
Now, while that makes sense, many people struggle to apply those principles because the media tends to look at investing through a different lens, focusing on today’s news, which is already priced in, or on speculating about tomorrow. Guesswork makes for interesting television. But is it relevant to your long-term plan? Probably not.
As always though, a disciplined approach and a diversified portfolio continues to be the best approach in these times.
We greatly appreciate the opportunity to work with each of you and hope you have been enjoying this autumn season. As always, if you have any questions or concerns, please contact us and we would be happy to discuss.