Just months ago, in the closing weeks of 2018, financial markets were undergoing considerable volatility. As the Fed raised rates, many were concerned that the economy would stall and even lead to a recession. Political saber-rattling around international trade also put many on edge. The gains of early 2018 melted away in a jarring fourth quarter decline. From the highs of the summer, stocks flirted with a decline of 20%, the classic definition of a bear market.
The financial media fanned the flames. Even though the declines of calendar year 2018 were modest, pundits called the end-of-year drop the worst December since the Great Depression and the worst Christmas Eve trading decline in history. The Christmas Eve reference was especially confusing, as we hadn’t previously seen financial returns posted for individual holidays. What’s next, the worst Groundhog Day since World War II?
As misleading as some of this information was, some investors didn’t take the decline well. The Investment Company Institute reported that during the third week of December, investors pulled $54 billion from stock and bond funds. Some experts advised changing portfolios and weightings due to the diminished expectations for the future, even though little about the economy had changed.
As is often the case, things were not as dire as they seemed. The Fed signaled that interest rates had temporarily peaked, and future rate cuts were possible. While trade tariff wrangling continued, there was hope for an agreement. Against that backdrop, both stock and bond markets surged. The headlines now display a notably different tone. A front-page Wall Street Journal article from the end of June 2019 declared, “Stocks Cap Best First Half Since ’97.”
While we don’t necessarily enjoy wild market swings, we know they are inevitable. We try to exercise restraint in the face of dramatic headlines and focus on the long-term goals of our clients. Noted British scientist and Royal Medalist, Thomas Huxley, once wrote, “Patience and tenacity of purpose are worth more than twice the weight of cleverness.” These ideals are nothing new—Professor Huxley was born almost 200 years ago.
Recently there has been a lot of press regarding the inversion of the yield curve. This occurs when the yield on the 3-month Treasury exceeds the yield on the 10-year Treasury. The narrative is that once this occurs, a recession is almost always near. History shows that an inversion has occurred roughly twelve times since 1966. One year later, the market has been positive 55% of the time. So much for divining forecasts and investment strategy based on a single data point.
Recessions will come. Market declines will come as well. Our approach is not to avoid them with clever-sounding but ineffective predictions, but to prepare portfolios to weather these inevitable events.
Domestic Equities: For second quarter 2019, U.S. stocks continued to climb. The S&P 500 added 4.3%. Year-to-date, the index bolted to a 18.5% gain. Smaller U.S. companies rose 3.0% for the quarter and are up a powerful 19.2% this year. The size of these gains may act to embolden some investors, but it does not have that effect on us. Just as we keep declines in perspective, we do the same with large gains. It is the long-term that matters.
Fixed-Income: Bonds move inversely with stocks from time to time. When equities are weak, bonds may rise as investors seek the relative safety of fixed-income. When equites are strong, bonds sometimes are weaker as some fear an eventual rise in rates due to the strong economy. This has not been the case this year. As the Fed signaled a potential reversal in policy toward rate hikes, bond prices jumped. The Barclays Aggregate, a measure of the total bond market, rose 3.1% for the second quarter and is up 6.1% for the calendar year. While modest compared to stocks, this return is a strong one in the relatively-muted bond world. Municipal and high-yield bonds also turned in strong results for the quarter and year.
Considering that the 10-year Treasury yield has declined from over 3% to under 2% in a relatively short time, we would not expect these large returns to be sustainable over the long term. This is not a reason to make a bold move in reducing bond exposure—but to merely be aware of the cyclical nature of returns.
International Equity: Stocks of companies outside the U.S. also benefited from the strong first half. The MSCI EAFE Index, a measure of international stocks in developed countries, moved up 3.7% for the second quarter and is up 14.0% year-to-date. One might think that given the tariff and trade issues, emerging markets stocks would be weak considering that Chinese stocks make up almost a third of the MSCI Emerging Markets Index. That wasn’t the case. The global rally was so strong that even emerging markets stocks advanced. The index eked out a gain of 0.6% but is up 10.6% for the year.
We are happy to see both the equity and fixed-income markets turn in such strong results for the first half. As good as these returns feel, six months isn’t likely to matter that much in the long term. We manage portfolios that are often multi-generational. We know that capital requires considerable sacrifice to achieve. Our advice is intended to benefit not just the current generation but also generations to come. So, rather than reacting to a great or poor six months, our preferred timeframe is related more to what is important to you. That, along with patience and purpose is core to what we do.
Please let us know if there is anything you need or if you just want to talk.