A little over five weeks ago we had the second big election shock of 2016 (following the "Brexit" vote in June) when Donald Trump, a 3-to-1 underdog, won the US Presidential election. As the saying goes, "the markets hate surprises", and in my nearly 30 year career these are certainly two of the biggest surprises we've experienced.
In this post, we'll look at two important issues:
1. The lessons we can learn from how the markets reacted to this most recent surprise
2. How we might approach the investment world as it stands today
And before we get into this discussion, it's important to remember that we're trying to look at this from an unemotional perspective focused on the economic impact of the election. I fully understand that this election was about far more than economics, but it's long been said that emotions are the worst enemy of an investor, so the more we can try to set aside emotion and focus on the economic impact of this new administration on our finances the better off we'll be in the long run.
First, let's go back to the weeks leading up to the elections. Below are a few quotes (along with links to the full articles) capturing what the sentiment was among market "pros" heading into the election.
MIT Professor Simon Johnson on MarketWatch.com 10/31/16: "A big adverse surprise — like the election of Donald Trump in the U.S. — would likely cause the stock market to crash and plunge the world into recession."
From CNN Money article 10/24/16: "If Donald Trump wins the election, U.S. stocks (and likely many other markets overseas) will almost certainly tank. How big of a drop? Forecasting firm Macroeconomic Advisors predicts an 8% fall in the U.S. A new paper out Friday from the Brookings Institute projects a 10% to 15% nosedive. You get the idea."
Mark Cuban in Fortune magazine 9/7/16: “In the event Donald wins, I have no doubt in my mind the market tanks,” Cuban said.
This captures the prevailing wisdom at the time: a Trump victory would almost certainly spell doom and gloom for US stocks. Yet here's what actually happened post-election (November 8th close to December 16th close):
US stocks (S&P500) +5.94%
International stocks (EAFE Index) +1.38%
Intermediate-term US bonds (7-10 yr Treasury Index) -5.82%
Long-term US bonds (20+ yr Treasury Index) -10.32%
So Trump wins, stocks rally, and bonds get hammered. Pretty much the exact opposite of what Wall Street pros predicted...
Issue #1: what can we learn from this?
First, we once again see the fallacy of trying to predict short-term moves in the markets. While an entire industry is built around newsletters and websites that claim to be able to predict the future, not only is it a fools game, but this kind of investing mentality can cause long-term damage to your portfolio. Here's a good article from Kiplinger's on this issue. It's probably not a stretch to say that as the election results became clear the vast majority of investors would have jumped at the chance to spin the clock back 24 hours and sell all of their stocks, yet that would have been a very costly decision.
So what is a good way to approach situations like the elections where there was a large perceived risk to your portfolio? Adjust your risk on the margin, to a point where you're comfortable with whatever outcome there is. For example, heading into the election, it was entirely reasonable to go from having 70% of your portfolio down to 60% or even 55%. Take some risk off the table, turn the volume down a bit, to a point where you won't lose sleep worrying about the outcome but you'll also be positioned so that an unforeseen reaction (like stocks rallying on a Trump victory) will still benefit you. Market pros continually adjust their risk profile, particularly ahead of significant events that could impact markets. But adjust risk on the margin: going from 100% invested to 100% cash rarely works to your advantage. While you sacrifice some "opportunity cost" of not being fully invested if stocks rise more importantly you avoid the dangerous "knee-jerk reactions" that can come with being fully invested when negative surprises happen.
This brings us to issue two: with such an unexpected reaction in investment markets to the election of Trump, what should we expect going forward?
In the weeks since the election, markets have focused on the stimulative policies Trump has proposed: corporate and individual tax reform, infrastructure spending, less regulation, policies that generally help and economy grow. Much of the positive impact of these policies has rapidly been "priced in" to the shares of companies who stand to benefit. For example, bank stocks have rallied on average 17% since the election, and energy stocks are up 11%. So far it feels like a "honeymoon" period, where all of the positives capture the market's attention, and seemingly there are no negatives.
At times like this, it can be helpful to look back at why so many prognosticators thought stocks would "tank" if Trump was elected. Are any of the concerns people had back then still valid? Clearly the concern of the uncertainty in policy and approach to governing that a newcomer like Trump might bring to the White House seems valid. And the impact of protectionist policy (moving away from free trade) still seems valid. How the US relates to important world powers like China and Russia still is very much in question.
Taking some risk off the table pre-election was not flawed thinking, and with markets up since the election if you still have deep concerns about what the next four years might bring, if you still agree that some of the pre-election concerns are valid today, maybe this is an opportunity to adjust the risk in your portfolio to a level where you feel confident that whatever the markets do you'll be ok with the ride.
As always, I'm here to review your portfolio, goals, and risk, and I'd welcome the opportunity to help you ensure you're on track to meet your goals and still sleep well at night.
I recently spent three days at the SEI Strategic Advisor Council National Meeting, where leaders from SEI's Investment Management, Practice Management, Technology, and Trust Company segments provided us with a wealth of information and updates. While most of the information is probably not of interest to my typical client ("that's why we have you!"), there was one presentation in particular that could be of incredible value to you.
Over the past few years, the investment world has been a strange place. While asset classes typically move in and out of favor year to year as the chart from SEI below shows, large US stocks (as highlighted by the yellow blocks) have been one of the best performing asset classes for three straight years. To show what normal "in and out of favor movement" looks like I also highlighted international stocks, which have done better than US stocks in 8 of 15 years, worse in 7 of 15 years.
This three year run is very uncommon, and the staggering difference in performance (36% better than foreign stocks, 71% better than emerging market stocks, 96% better than commodities!) begs the question of why not just have all our money in large US stocks?
This is a very common reaction among investors, following the momentum by buying whatever stock or asset class that has done well recently, so you're not alone in posing that question.
Sometimes investors will do the opposite and take a contrarian view, looking to buy whatever did the worst the prior year figuring on a rebound.
And some investors, myself included, believe a diversified portfolio spread across a variety of stocks and bonds is the best approach, offering less risk and better returns over time.
So in light of this unusual outperformance of one part of the investment world, SEI tested all three strategies (momentum, contrarian, and diversified) to see what the real world risk and return would look like. The results were a real eye-opener:
What this study shows is that spreading your money equally across all of the asset classes generated a fifteen-year return that was higher than either the momentum (best of previous year) or contrarian (worst of previous year) approach, and with much less volatility (risk).
Of course there's an incredible amount of media effort, newsletter solicitations, and natural emotional temptation to forecast markets and predict the future. Just think about this 15 year period in the study: in 2000, everyone believed dot-com stocks were the road to riches, then in 2005 it was real estate, then in 2008 it was cash. But as this simple study shows, the most successful investors are often the ones who stick to a diversified investment approach suited to their goals and risk appetite.
This presentation was one of the most talked about among the 150 top-flight financial planners attending the conference, and I'd encourage you to absorb this info and ask me questions if you have any. For more information I also have a research piece from SEI on my website, you can click here to access it.
Kevin Kennedy, CFP®
As you've probably heard, the stock market has had a very rough start in 2016. The US stock market, as measured by the S&P500 Index, is down about 8% thus far in 2016. I know many of you have two main questions about this, and I'll try to answer them here as simply and concisely as I can. But as always you're welcome to call or email me if you'd like more info or to talk about your portfolio in particular.
Question #1: What is going on??
If you remember, in August-September of last year we had a correction of about 12% (and n the month of October we recovered pretty much all of that decline). This has so far been a very similar correction, driven by some of the same concerns:
- · China continues to show signs of a slowing economy, causing concern over the impact on all of the world's economies.
- · Oil continues to drop, reaching 14-year lows today under $30 per barrel (18 months ago oil was well over $100 per barrel).
- · In the US, our Federal Reserve raised short-term interest rates in December, a move which was widely anticipated but causes concern because higher interest rates can slow economic growth.
All of these are valid concerns, and all have existed for the better part of the past 6-9 months, but markets in the short run can be driven by emotion, running from fear to complacency back to fear in no time (sometimes in one day!).
All of these issues are closely watched and assessed by not only SEI in determining how our investment allocations should be adjusted on the margin, but also by the managers within our portfolios who are deciding which industries and companies should be bought or sold within their fund.
How bad will it get/When will it stop???
First, let's consider how drastic/unusual this type of decline is. Corrections like this have been rare in the past three years, but over the prior 19 years we've had 10% declines at some point during the year 75% of the time. Over the past 36 years we've averaged intra-year declines of 14% but ended with positive returns for the year 75% of the time. So it's very common for markets to go through rough spells, and it often doesn't translate into bad years.
While trying to predict market moves is tough (some would call it a "fool's game"), it's important to look at the fundamentals as we know them today to help us answer the question of what is possible with the stock market.
- · The US stock market by most measures is not overvalued (unlike in 2000 or 2007, when stocks were highly valued by many measures). In an environment where alternative investments (bonds, cash) offer very little return, it's unlikely that stocks would get exceptionally "cheap", a lack of viable investment options in and of itself should support stock prices.
- · Dividend yield on the broad market is again greater than the yield on 10-year Treasury bonds, a condition seen only a handful of times over the past 50 years, generally near market bottoms rather than at market tops.
- · Economic growth in the US, while tepid, is positive, and inflation is non-existent.
- · Corporate balance sheets are in great shape, unlike in 2007-8 when many companies had over-leveraged and unprepared for an economic slowdown.
Given that backdrop, it's hard to make the case for a repeat of the 50% declines we saw in 2000-2 and 2007-9. It's entirely possible we could see another 10% on the downside, which would be quite common (20% declines, "bear markets", historically have happened every 3-5 years). It's also possible that emotions are reaching a peak, and the majority of the decline has already happened. Being a planner, I'd suggest hoping for the latter but mentally preparing for the former.
To translate this possible 20% decline into the impact on a portfolio, in a balanced 60% stock/40% bond portfolio you'd probably see a 12-14% decline. Most all of you have some allocation to bonds, and it's important to remember that bonds typically go up when stocks go down. While we can't prevent the market from having down times (but we all wish we could!), we insulate ourselves from the full force of the swings by owning some bonds. Portfolio Construction 101: Diversify.
Don't hesitate to contact me if I can help with your situation.
Global stock markets had their roughest week in a few years, culminating with sharp declines Thursday Aug 20 and Friday Aug 21. After an abnormally long period without a significant decline (3+ years!), this volatility will certainly capture the attention of both the media and investors. Is this the long-awaited 10-20% correction? Or just a temporary set-back? An honest person will give you the honest answer that no one knows for sure, but I'll give you some info and thoughts to help steer you through whatever the markets have in store.
First, a picture. Here is the S&P500 Index over the past 10 years:
As you can see, we've had a smooth and strong rise since 2011. Even after the pullback the past few weeks the market is up 80%+ over that timeframe. At the close today the S&P is about 8% below the al-time highs reached three months ago.
To understand the reasons behind the declines, here are three articles summarizing the situation (the article will open in a new window):
A little over a month ago (July 9) I made a blog post discussing the possibility of a correction in the stock market, and what I said then is still true today:
"The US market hasn't had a correction (10%+ decline) in more than three years (corrections normally happen every 18 months or so), so we're way overdue for a pullback. Could this be a 30-50% collapse like we saw in 2008-2009? Most market analysts agree that stocks are not extremely overvalued and the backdrop isn't there for such a decline, but 10-20% would not be out of the question and in many was it would be healthy in the long run.
Bottom line: Whether we're at a correction point or not, it's always a good idea to consider your risk tolerance and goals and confirm how your investment portfolio is positioned. In most cases, a 20% decline in stocks would translate into a 10-15% decline in a balanced, diversified portfolio. If you have discomfort with the prospect of that happening, talk to me and we'll take whatever steps necessary to make sure you're positioned to ride out that scenario. And if you have cash, such a correction could be the time to buy."
Much like the recent 4.0 earthquake we had recently in the Bay Area, which came after a long period of no quakes, this decline may feel strong, but again much like the quake it's a natural part of the market cycles.
Should the outlook change, I'll share my thoughts and recommendations with you.