This blog intends to provide an update on the state of the domestic and international stock and bond markets, as well as provide insight into the macroeconomic backdrop.
Stocks & Bonds
After a roaring start in January, the next two months knocked the Dow Jones Industrial average to a 2% loss for the quarter, while the S&P 500 Index lost 0.8%. Only two of the eleven sectors posted gains this quarter, Tech and Consumer Discretionary, gaining over 3%. Smaller firms (S&P 600) were able to hold onto a very marginal gain of 0.6% as of March.
Noteworthy is the fact that International developed markets (S&P x-U.S.) were not immune to the U.S. volatility, losing 1.7% as of the end of Q1. However, emerging markets (S&P) performed much better, posting a 1.4% gain for the same period.
For those who own bonds in your portfolio, you’ll be glad to know they achieved their objective, – limiting losses relative to the overall stock market. However, the overall bond index was not immune to the increased volatility. The Barclay’s Capital Index lost 1.4% while the 10-year Treasury showed a modest gain of .28%. The bond volatility is likely aiding in explaining a portion of the stock market’s volatility.
The investment team at Lighthouse Financial has been communicating to our clients for the past several months to anticipate a return to a more normal market environment and a spike in market volatility as we transition to the later stages of the economic cycle. We highlighted this in our recent blog (‘Focus on Long-term Fundamentals’), pointing out that we are now much closer to the historical average of 20 for the VIX. “How long can a market go without a single monthly decline” was answered in February 2018.
At this point in our quarterly update, we would usually delve into the nuances of domestic and global markets, throw in a little macroeconomics for good fun and maybe a few graphs, for easier reading. Instead, we wanted to point out that during times of heightened volatility or uncertainty in the markets, investors and portfolio managers don’t fail due to a lack of lack of knowledge. They fail because they do not have a plan or they ignore it because of external emotional inputs.
“Choosing individual stocks without any [plan] is like running through a dynamite factory with a burning match. You may live, but you are still an idiot.” - Joel Greenblatt’s The Little Book that Beat the Market, altered
This quote pretty much sums it up. If you and your advisor do not have a clear and defined plan on how to invest, you may do fine. Alternatively, you may financially blow yourself up! Having a plan does not guarantee a positive outcome, but it will significantly reduce the probability of a very negative result. Stay on point with your long-term goals and objectives and take the time to meet with your Wealth Manager regularly to review your financial situation and monitor your progress towards your longer-term goals.
What not to do in this market environment
Don’t let increased periods of volatility change your long-term plans or investment preferences if your goal has not changed. For instance, in the 20 years since 2015, the market gained approximately 8.2%. However, the average self-directed investor realized a 4.7% return(Dalbar, Quant. Analysis of Investor Behavior, 2016). That is even less than the 5.3% returns generated in the bond market during that same period. This statistic highlights that the average self-directed investor took on the full risk of the stock market over the past 20-year period but achieved less than the bond market returns. I think it is safe to say that the average self-directed investor did not have a clear plan or did not follow their plan. While there are many common mistakes investors make that lead to the results above, below are two timely examples:
Anchor (and adjust) bias: To test this bias, you would need to ask yourself the question, are bear attacks or shark attacks more common. Depending on whether you live near a forest or near the coast, you are more likely to hear the appropriate set of stories on the news, influencing your answer. However, folks who lived in the Midwest are also unlikely to guess the duller answer; both have about the same number of attacks. In fact, cows injure ten times more than both sharks and bears combined. Cows do not make the news channels top story. For the same reason that CNBC news usually finds a compelling narrative for the next 15 minutes, or last month’s market movements, the reality might have little or no relation to that story. As an investor, every sale or purchase always has someone at the other end buying or selling that stock. By understanding their thesis, inevitably the opposite argument, allows us to appreciate where logical gaps might be.
Recency (or Myopia, or Availability) bias: while this bias goes by many names, it is referring to a higher emphasis placed on of recent, usually emotional, events. A common example relates to the fear of flying and its prevalence in the news. While there were about 400 aviation-related deaths in 2016, there was 100 times that number of auto-related deaths, about 40,000. The reality, to revert to the recent market drops, is that the eight years of a bull market, or a demographically changing U.S. population, bears more relevance than the last couple of month's tariff or interest rate movements.
We have focused on what not to do, now let’s take a look at what successful investors do.
They Have a Goal in Mind
"Army pilots… looked at their shiny new Model 299 bomber – a machine so complex no one was sure human beings could fly it. They could have decided just to "try harder" or to dismiss a crash as the failing of a "weak" pilot. Instead, they chose to accept their fallibilities. They recognized the simplicity and power of using a checklist." - Atul Gawande, The Checklist Manifesto, How to Get Things Right
It may seem as if finding a foothold to begin investing can be as complex as flying an aircraft. The reality is that, with the help of your Wealth Manager, it is much simpler. The quote above comes from the Checklist Manifesto, a book now commonly used as a basis for tasks as complex and diverse as brain surgery to NASA space missions, and our focus, finance.
As my first quote stated, without a goal of investing, it is impossible to make progress. If your goal is to have enough for retirement, and you are 90% towards your goal, whether Ford or Microsoft should be in your portfolio is less relevant than the level of stocks versus bonds. The rest of the checklist would obviously be more focused, but please take advantage of the meetings your advisor's schedule, to determine where you are towards your personal goal with your assets.