Filbrandt Reports

The Market Is Up Nicely This Year … Or Is It?

Volume 18, Issue 4a

Executive Summary:

In this Market Update, you will learn:

  • Why your portfolio performance may not have met your expectations
  • Why some of last year’s strong gains have been lost in 2018
  • Fundamental market improvements that are being obscured
  • The goal you should always prioritize

The S&P 500 index is up around 10 percent year-to-date, and the tech-heavy NASDAQ index is doing even better. These gains might have investors excited to open their monthly investment statements, but often they are left feeling disappointed and questioning why their portfolio perfor-mance did not meet expectations.

U.S. stocks make up a significant portion of most diversified portfolios, but there are other investment categories. Within the equity sector, portfolios typically have international exposure to both developed and emerging countries. These stocks were up 25 to 35 percent in 2017 with the help of a weak U.S. dollar. A weak dollar has the effect of increasing foreign returns for U.S. investors, as those gains can now buy more dollars. Some of last year’s strong gains have been given back in 2018, partially due to a rebounding dollar. We continue to find international stocks attractive, as they are generating strong earnings growth and appear very inexpensive relative to U.S. stocks from a historical perspective.

The MSCI ACWI Index (All-Country World Index) is a popular benchmark that consists of roughly half U.S. companies and half foreign. Large companies represent 70 percent of the bench-mark with small- and mid-sized companies accounting for the remaining 30 percent.

This benchmark serves as a good barometer for the global equity market. Through late September, the benchmark was up only 2.6 percent due to low or negative returns in markets outside the U.S. More than half of the stocks in this benchmark are in bear market territory, meaning they have gone down in value by more than 20 percent from their highs.

The fixed income market, i.e. bonds, has also been dragging portfolio returns down this year. Most bond benchmarks are down about 2 percent for 2018 due to rising interest rates, not exactly what most investors expect from their “safe” assets. In the long run, gradually rising interest rates will allow investors to receive higher yields from their bond investments.

Taking a broader perspective of the investment universe, Morningstar and Vanguard both have asset allocation models that represent diversified portfolios and are balanced between stocks and bonds. Through August, the models for a 40 percent equity / 60 percent bond portfolio returned 1.5 and 1.3 percent, respectively. The 60 percent equity / 40 percent bond models have returned 2.3 and 3.5 percent, respectively. These types of performance numbers may fall short of investor expectations, given the headlines of strong U.S. equity returns.

Fundamental improvements being obscured

The mixed market results and lower portfolio returns over the short term are obscuring some important fundamental improvements. U.S. corporate profits were up 25 percent in the second quarter versus a year ago with 80 percent of companies beating their estimates. Overall, this is the best earnings report of the past 10 years. The strong earnings have also helped reduce stock market valuations (e.g., measures of whether stocks are expensive, such as the price-to-earnings ratio) to levels more in line with historical averages.

Most economists are expecting the economy to slow down, but not go into recession, in 2019. Slow but steady growth has served the stock and bond markets well for much of the past 10 years. The primary risks to this scenario include more rapid inflation and the continued escalation of the trade wars. Normal market volatility is expected to continue, which means 10 to 20 percent stock market corrections are common.

Goal is always long-term financial success

The best plan in any environment remains a long-term commitment to an appropriate asset allocation and a consistent and disciplined approach to the market. This approach includes a focus on valuations and keeping emotions out of portfolio decisions. The goal is always long-term financial success, not positive returns over short periods of time.

Volume 18, Issue 20

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