MARKET UPDATE: SECOND QUARTER 2019
In Q2, U.S. markets – led by financial-sector stocks and long-term bonds – spearheaded a broad-based appreciation in equity and fixed income assets around the world. During Q2, the U.S.-China trade tension escalated, providing an additional source of concern about the global growth slowdown. The world’s major central banks, acknowledging the weak global backdrop, shifted their tone more clearly toward an easing basis. These factors stoked volatility in global equity markets, while government bond yields dropped further. Both U.S. equities and bonds benefitted from the dovish shift in tone from global monetary policymakers that many investors hoped would lead to lower policy interest rates and greater liquidity growth.
Global growth momentum continued to slow and most major economies have progressed toward more advanced stages of the business cycle, The U.S. is firmly in the late-cycle phase but with low near-term risk of recession. Ten-year Treasury bond yields ended the quarter below 3-month Treasuries, inverting the yield curve. Curve inversions have preceded the past 7 recessions and may be interpreted as a market signal of weaker expectations relative to current conditions. However, the time between inversion and recession has varied significantly.
A strong labor market and higher wages have buoyed consumer confidence. Although consumer sentiment remains positive, the large gap between current conditions and forward expectations has often occurred toward the end of prior economic cycles. The improvement in wage growth over the past two to three years has stalled in recent months despite a cyclically low unemployment rate and continued job gains.
Geopolitical tensions always have the potential to be a wild card in the investing deck, with today’s card being heightened potential for military conflict between the U.S. and Iran. Although it may pose another threat to an already-vulnerable global economy, markets’ past negative responses to U.S. military strikes has tended to be short in duration.
We continue to recommend investors stay at their long-term strategic equity allocation with an eye to diversification, and using volatility to rebalance as needed.
THE IMPORTANCE OF STAYING THE COURSE
When the market gets jumpy, so do investors. In periods of volatility, anxious stock market investors can be tempted to take money off the table, fearing a potentially major slide in their portfolio. Take this past May, for example. Stocks began to waver early in the month, when a presidential tweet regarding tariffs re-inflated investor concerns over a possible trade war between the U.S. and China. Investors responded by moving their money from equities to fixed income. Investors who missed out on the May downdraft made out. Say you were able to exit stocks following the president’s May 5th tweet. You would have avoided a 6.6% slide in the S&P 500 from then through May 31. But before congratulating yourself on a savvy piece of market timing, ask yourself if, or when, you planned to buy back in. After all, from the end of May through June 14, the market had already bounced back by nearly 5%.
Stay invested – exiting stocks amid a turbulent market may help assuage your anxiety, but you are likely to miss out on substantial gains while you sit on the sidelines. That’s because much of the market’s long-term performance is driven by returns from a few outstanding days. Remember the S&P 500’s 15.1% annualized return over the course of the current bull run? If we leave out the five best days of each year for the market, the annualized return plummets to a measly 1.1%. On an initial $10,000 investment, that’s the difference between ending up with about $40,000 and about $11,000. And if you think you’ll be able to pinpoint when to exit and then get back in the game, think again. Since the bull began in 2009, 40% of the market’s five best days of the year have occurred within a week of the five worst days. Investors who don’t have a crystal ball are better off staying fully invested than attempting to wring gains from short-term market timing moves.
It helps to anticipate short-term bouts of volatility and to have a plan in place for when those stretches occur. Make sure your portfolio’s asset allocation aligns with your tolerance for risk. If a major decline in the stock market would keep you up at night or cause you to panic and liquidate your nest egg, consider pruning back your stock allocation or adding an investment intended to mitigate volatility.