FAQs About the Ups and Downs of the Markets
1. I lost money last year, that’s disappointing. I thought the economy was doing pretty well, what happened?
Last year was a difficult one, even for diversified portfolios. We build diversified portfolios that allocate to growth assets in the form of equities, inflation-protecting assets like commodities and real estate, and income-oriented investments, namely bonds. Over the long run, diversification helps to minimize risk, but there are certainly years where a diversified portfolio can lose value. Last year was one of those years, and it’s something we plan for when we create a client’s financial plan and make projections about the future.
Financial markets tend to be volatile and lumpy in their returns. They also tend to be discounting mechanisms. Last year, there was a lot of good news on the U.S. economy and also on corporate earnings. But, much of that good news had been anticipated in 2017, which was a much stronger year for almost any asset class and had an almost historic lack of volatility.
Now, looking ahead, the earnings outlook is a little cloudier and so is the economic outlook. We’re slowing from a high level of growth and that could keep volatility elevated in the year’s first half.
On a positive note, we have seen signs that policy at the Fed may be less restrictive this year and globally, growth could potentially turn higher in the second half. And, we could expect positive returns by the time the dust settles in 2019.
2. Why did a number of stock strategies underperform the S&P 500?
First and foremost, we know that everyone needs to benchmark to something to somehow gauge how they’re doing. Big U.S. indices like the S&P 500 or the Dow are front and center but are a sub-optimal benchmark for us and our clients. The S&P 500 is a measure of the 500 largest companies in the U.S. but that does not capture the entire world of opportunity. A still imperfect but more appropriate benchmark in our mind is a global one.
To directly answer the question, we can think of two major reasons why our portfolios may not have kept up with the S&P last year. The first is that we invest globally, and international equities did not perform as well as U.S. stocks. The second is that we take a “value” approach to our investment strategies. For much of the year last year, the winners were Amazon, Apple, Nvidia, names that have had strong earnings growth but have become very expensive. Amazon, for instance, trades at 90 times its earnings, which is much higher than the S&P 500, which trades around 18 times earnings. A lot of good news has been priced into names like that and even they had a rough fourth quarter. High flyers can make headlines and produce amazing returns in any given year, and we do have some broad market exposure and Growth positions that will pick up some of these high flyer stocks; however, we think a value approach is the best way to try and maximize your returns while taking as little risk as possible.
3. Why would we invest internationally at all?
This really comes down to two major factors. The first is that the majority of economic growth is coming from economies outside of the U.S. The U.S. is still a big part of the pie but shrinking every day. And, we’re using our research partners and working with our team to do our best to set you up for long-term success. The second is that valuations are much more compelling, and these things tend to run in long cycles. Valuation is not a great timing indicator, but it can be terrific at framing a 10-year return expectation. From that perspective, international stocks have a more compelling starting point.
4. Bonds were down, I thought that was my safe income. What gives?
The economy was pretty robust last year, and the Fed was hiking rates. Historically, when the Fed is tightening policy, rates tend to go higher. The good news is that many believe that the Fed looks like it is going to pause its hiking cycle and see where the data lands. Rates are much higher and bond prices become less sensitive to small moves in rates as the starting point on rates is higher. Also, bonds did really well in the fourth quarter when the equity markets were selling off.
5. Do you think the return assumptions modeled in my cash flow plan are valid?
Yes, for a few reasons. One, inflation and interest rates were really low for the majority of this bull market. Inflation-adjusted returns are in line with historical norms. Higher rates alone should give you more return in your bond portfolio. Additionally, international and real assets have been a drag. So even though the U.S. has been high flying, some other areas of the portfolio have been somewhat weak. We expect that even if returns in the U.S. portion moderate, these areas will become positive impacts.
6. Can things actually get any better this year? It seems like it’s just getting worse.
Again, it looks like policy at the Fed is going to be less restrictive this year and that globally, growth is going to turn higher in the second half. And, we expect positive returns by the time the dust settles in 2019.