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Hello Volatility, We've Been Expecting You

After an extremely pleasant and unusual 2017, equity markets are now doing what they normally do. They are going up AND down, sometimes violently. The excellent chart below from Goldman Sachs Asset Management1 demonstrates just how calm and peaceful 2017 was in comparison to history and shows just how normal 2018 has been. (Data through November 3rd, so we are much closer to average over the last month). While this volatility can be uncomfortable, it’s simply not unusual.

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Between September 1st and last Friday’s December 7th close:

  • The S&P 500 (SPY) is down 8.80%
  • The high flying, tech-heaving NASDAQ 100 (QQQ) is down 13.38%
  • Small Cap US stocks (IWM) are closing in on bear market territory (20% or greater decline from previous high) down 16.54%
  • International Developed Markets (EFA) are down 9.79%
  • Bonds (AGG) are up .18%

(All data is from our friends at Koyfin2. I’m using sample Exchange Traded Funds that track the various indexes represented. Ticker symbols in parentheses)

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Year-to-Date through last Friday, December 7th:

  • The S&P 500 (SPY) is eking out a small gain of .06%
  • The NASDAQ 100 (QQQ) is up 4.19%
  • Small Caps (IWM) are down 4.72%
  • International Developed Markets (EFA) are down 11.88%
  • Bonds (AGG) are down 1.05%

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This follows an incredible 2017 where all major asset classes posted positive returns. It’s also been a remarkable ten years since the global financial crisis. The same chart below between January 1st, 2009 and last Friday, December 7th:

  • The S&P 500 (SPY) is up cumulative 256.13 %
  • The NASDAQ 100 (QQQ) is up cumulative 499.23%
  • Small Caps (IWM) are up cumulative 235.98%
  • International Developed Markets (EFA) are up cumulative 80.44%
  • Bonds (AGG) are up cumulative 32.69%

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While it’s easy to look back and see these amazing return numbers, it’s important to remember that getting here has been anything but easy. In 2009 the world was falling apart as individuals, corporations, and governments dealt with massive debt defaults and no one had any confidence the world as we knew it would continue. In August 2011 Standard and Poor’s lowered the nation’s credit rating noting ““political brinkmanship” in the debate over the debt [which] made the U.S. government’s ability to manage its finances “less stable, less effective and less predictable.””3 The S&P 500 (SPY) would fall 17.49% between July 1st and October 3rd that year4. And more recently, beginning in the summer of 2015 and extending through early 2016, the S&P 500 dropped 12.98% on a slowdown in China coupled with a massive fall in oil prices.5

Myriad reasons have been cited for this most recent correction and I think it’s important to create realistic expectations. We are facing potential headwinds that are pointing to slower growth both here and abroad for the foreseeable future.

  • The Fed is raising rates to cool inflation pressures and keep the economy from overheating. It’s working. Higher rates are affecting interest rate sensitive areas of the economy such as housing, as it now simply costs more for individuals and businesses to borrow money.
  • The unemployment rate remained at 3.7% as of last Friday’s monthly jobs report6. How are companies to sustain current growth rates without qualified workers?
  • We’re in the middle of an international trade skirmish causing economic uncertainty and real cost increases which will eventually trickle down to consumers. “Tariff Man”?

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While no one knows if these points lead to a slow-down or to an actual recession, it’s important to understand that the next ten years may not look like the previous. We have been running financial planning projections over the last several years based on lower return expectations and have built this into our financial plans. However, it’s still important to adjust personal expectations around this possibility. According to Charles Schwab, forecasts for real GDP growth are moderating7.

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Finally, I’ll leave you with a few closing thoughts and a chart. 

  • The only thing we can say with a fair amount of certainty is that another correction AND another bull market will happen sometime in the future. We will never know the timing, duration, or severity.
  • Because of this, we diversify, rebalance, and follow a disciplined process based on the unique situation and goals of our clients. There is no such thing as a successful market timer.
  • A globally diversified portfolio of stocks and bonds can limit the volatility experienced during these times. A diversified investor has accepted returns lower than owning US stocks alone over the last ten years. It’s during these volatile times that the diversified investor can be rewarded.
  • I’ve updated the same chart from above, September 1st thru last Friday, December 7th. This time I’ve added a proxy for a globally diversified 60% stock/40% bond portfolio, the Vanguard Lifestrategy Moderate Growth Fund (VSMGX). The goal is to demonstrate the experience a balanced investor has had relative to non-diversified exposure to individual asset classes.

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We always welcome your questions, comments, and feedback. If you’re experiencing anything more than the normal discomfort associated with a long-term investment strategy, or simply want to review your plan, let us know so we can schedule time to visit.

Happy Planning,

Brian


1. Goldman Sachs Asset Management Weekly Market Monitor – Week Ending November 23, 2018

2. Source Koyfin: Price data for equities and ETFs is adjusted for dividends and splits. That means that performance information is total return including dividends. Illustrated returns from SPY, QQQ, IWM, EFA, AGG and VSMGX include the underlying expense ratios of the ETFs, but do not reflect potential transactions costs or investment advisory fees.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The S&P 500 Index focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market. The SPDR® S&P 500® ETF Trust (SPY) seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the "Index").

The Nasdaq 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care and others. Invesco QQQ is an exchange-traded fund based on the Nasdaq-100 Index®. The Fund will, under most circumstances, consist of all of stocks in the Index. The Index includes 100 of the largest domestic and international nonfinancial companies listed on the Nasdaq Stock Market based on market capitalization. The Fund and the Index are rebalanced quarterly and reconstituted annually.

The Russell 2000 Index® measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The iShares Russell 2000 ETF (IWM) seeks to track the investment results of an index composed of small-capitalization U.S. equities.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The iShares MSCI EAFE ETF (EFA) seeks to track the investment results of an index composed of large- and mid-capitalization developed market equities, excluding the U.S. and Canada.

The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds. The iShares Core U.S. Aggregate Bond ETF (AGG) seeks to track the investment results of an index composed of the total U.S. investment-grade bond market.

The Vanguard LifeStrategy Funds are a series of broadly diversified, low-cost funds with an all-index, fixed allocation approach that may provide a complete portfolio in a single fund. The four funds, each with a different allocation, target various risk-based objectives. The Moderate Growth Fund (VSMGX) seeks to provide capital appreciation and a low to moderate level of current income. The fund holds 60% of its assets in stocks, a portion of which is allocated to international stocks, and 40% in bonds, a portion of which is allocated to international bonds. Investors with a long-term time horizon who can accept stock market volatility may wish to consider this fund.

3. https://www.washingtonpost.com/business/economy/sandp-considering-first-downgrade-of-us-credit-rating/2011/08/05/gIQAqKeIxI_story.html?noredirect=on&utm_term=.da2f25c9aed1

4. Koyfin – SPY performance July 1st, 2011 thru October 3rd, 2011

5. Koyfin – SPY performance July 17th, 2015 thru February 11th, 2016

6. https://www.nytimes.com/2018/12/07/business/economy/jobs-report.html

7. https://www.schwab.com/resource-center/content/truce-he-said-xi-said#