A Guided Path Informs Your Decisions
Most of us are familiar with the expression “Don’t put all of your eggs in one basket.” Sage advice for all walks of life—if the fate of everything is dependent on only one thing--the proverbial basket--then dropping the basket could be catastrophic. The proverb calls for diversifying, or placing the eggs in different baskets in order to reduce the risk of a mishap leading to the loss of all your eggs. Simple enough— the concept applies directly to investing. Investor portfolios are often diversified across a wide array of not only stocks (especially for those investing via mutual funds or ETFs), but also various asset classes (such as bonds and commodities) and geographic regions. Unfortunately, to the chagrin of many investors, while diversification sounds all well and good in theory, in practice it often feels as if it is not working.
Global Equity Markets enjoyed strong returns in Q1 led by the Emerging Markets. Growth stocks lead Value as Technology stocks were a significant driver of returns, accounting for more than 40% of the S&P 500 Index gains in Q1. Despite the Fed's 25 basis point rate hike, intermediate term investment grade bonds (Corporates and Munis) still squeaked out positive returns in Q1. Commodities and Natural Resource Equities were some of the weaker performers in the first quarter as oil prices retreated by about 7.5%. High hopes that tax reform, reduced regulation and a more pro-business agenda would jumpstart the next round of growth in corporate earnings, have eased in face of failure to repeal the Affordable Care Act. The Fed has introduced a new wrinkle to the equation by suggesting that they may consider reducing their balance sheet later this year which raises the possibility that they may slow the pace of rate hikes. The weakened currency and rebounding global economy's benefit on the European markets is reflected through the European Manufacturing Managers Index (PMI).
Stocks are off to a fast start in 2016. Gains in each of the first two months have propelled the S&P 500 to an early 6% year-to-date return. The gains are even more impressive going back to November’s election—the S&P 500 is up nearly 12% since then and regularly hitting new record highs. Given such a strong run, and considering that we have not experienced a correction (a price decline in excess of 10%) in more than a year, many investors may be getting a bit wary. After all, the average annualized return for U.S. large cap stocks over the past twenty years is only 7.5%. But in our opinion, a strategy of relying on these types of mathematical averages is a little fuzzy, as markets seldom act average. In fact, calendar year stock returns are usually anything but average.
The stock market rally continued more or less unabated in February, with U.S. stocks hitting new record highs on an almost daily basis. While hopes of faster growth as a result of proposed business-friendly policies from the new administration are a large part of the story, an actual recent improvement in fundamentals (corporate earnings and economic data) should not be overlooked. The earnings recession is now in the rear-view mirror, which helps to provide an underpinning for the equity market. As stock prices surge to previously unseen levels, investors are starting to pay attention to elevated valuations.
According to a well-recited traders’ omen, "As January goes, so goes the year." The so-called January Barometer, as first mentioned by Yale Hirsch of the Stock Trader’s Almanac, suggests the performance of stocks in the first month of the calendar year dictates where prices will head for the year overall. With the S&P 500 scraping out a 1.8% gain to kick off 2017 (the index’s first January gain since 2013), followers of this fortune-telling phenomenon are likely cheering the prospects of a prosperous year ahead. But do simple rules of thumb such as this, which are particularly alluring to fall back on during political and policy uncertainty, really work?
Stocks got off to a decent start in 2017 on continued optimism that the new administration's fiscal policies will ultimately spur economic growth. January has been a tough month for the markets in recent years, and though stocks once again wavered near the end in face of political turmoil, the S&P 500 still managed to rise 1.9% for the month. It was the first January gain since 2013. The Dow Jones Industrial Average, meanwhile, breached the 20,000 mark mid-month for the first time ever. International markets did even better, with returns for U.S.-based investors benefiting from a decline in the dollar (which logged its worst month in nearly a year). The MSCI EAFE index of developed overseas markets rose 2.9% in January (in dollar terms). Emerging markets were the biggest winner, gaining 5.5%.
Thanks in part to the prospects of an accelerated pace of Federal Reserve rate hikes, many expect continued strength in the U.S. dollar as we head into 2017. If that turns out to be the case, the tangled web of currencies and corporate earnings could make it tough for U.S. markets to maintain their recent dominance. While a rising dollar hurts the near-term performance of non-U.S. investments (when translated back into dollar terms), over longer timeframes weaker foreign currencies can improve the competitiveness of businesses outside of the U.S.. Emerging markets in particular may benefit from stronger potential growth and attractive valuations, making them a compelling long-term investment opportunity.
U.S. stock markets wrapped up 2016 on a strong note, as the post-election rally continued in anticipation of the new administration's proposed business-friendly policies. For the S&P 500, December's 2% advance (including dividends), capped off the index's 8th consecutive year of gains. On the international front, emerging stock markets notched their first positive year since 2012 on signs of improving fundamentals, but developed overseas markets (Europe in particular) continued to lag due to slow growth and structural concerns.