Spinning Wheels – A Mid-Year Investment Review

BY: Mark Drachenberg

Sometimes it seems like you are spinning your wheels and never getting anywhere or to put it another way you seem to be going in circles.  Seems appropriate since the markets continue to spin their wheels and essentially go nowhere.  While the heightened levels of volatility have receded a bit, investors have faced a barrage of newsworthy events so far in 2018 that left many bewildered and confused as to what to do.  That is where asset allocation and a long-term perspective come in as they can allow one to (relatively) calmly sail through these bewildering markets.  As unusual as it may sound, however, a prolonged sideways move can act as a kind of correction that is somewhat easier to take than the gut-wrenching drops that a faster correction typically delivers. 

A sideways move.

While we have had good months (January, May) and not so good months (February) this year, the end result is a somewhat sideways move.  The Dow Jones Industrial Average is down 0.24% YTD while the S&P 500 is up 2.02%.  Small-cap and mid-cap stocks have fared better at 3.05% and 8.17% YTD respectively.  The high flier for the year is the tech heavy NASDAQ that has gained 8.31% YTD (all numbers through the end of May).  Fixed income hasn’t fared as well due to rising interest rates and inflation and there the U.S. Barclays Aggregate Index is down 1.50%.  International stocks have not fared as well this year as growth has stalled somewhat in Europe and this is reflected in the EAFE which is down 3.15% YTD.  All of this leaves an investor with a balanced portfolio struggling to reach a total return of just 2% or 3% so far this year.  While this isn’t great by any means, when one considers that we faced our first correction in over two years in February, it isn’t all that bad either.

So, sideways we go.  The S&P 500 has generally traded in a range of 2,600 to 2,800 for about three months now and how the market is reacting is essentially a textbook response.  According to Jurrien Timmer, the Director of Global Macro at Fidelity, “the S&P 500 continues to pretty much follow the textbook script of a bull-market correction:  an unsustainable surge to the upside, followed by a brief, violent decline (more than 10% in nine trading days from Jan. 29 through Feb. 8), then a swift recovery but to a lower high, followed by another down leg but to a higher low.” 

Are the bulls ready to run?

Does this mean we are still headed higher as the bull market continues or are we just biding time until the bear market pulls us significantly lower?  The bear market argument doesn’t seem to hold water as earnings growth is underpinning the market right now with year-over-year gains of 20% plus.  The earnings growth, at least for now, is strong enough to help the markets overcome negative news on multiple fronts.  Statistically, things have improved as well as the forward P/E ratio for the S&P 500 has declined by 17% or so but the markets only faced a decline of 10% this year.  That is good news as the market becomes more fairly valued without facing a more severe decline in market valuations.  This gives some credence to my earlier comment about a sideways movement not being so bad.  On the other hand, one is tempted to ask if the bulls are ready to run again?  While there may be some room to run, the markets do face some headwinds.  Global trade issues are in the news and in a not so positive way.  While this impacts many of us as consumers it definitely hits multi-national companies.  This helps to explain the better performance of small-cap stocks this year as they tend to face fewer international issues than their larger cousins do. 

The Fed didn’t raise rates in May but did so in June and seemed to indicate the potential for more rates over the next year or two than originally thought due to a strong economy.  While it is comforting to know that the Fed isn’t trying to surprise anyone, it is also true that higher, and rising, rates are generally tough on stocks.  Tied to the rise in rates is the fact that the U.S. economy is moving towards late cycle.  Yes, it is true that we aren’t there yet but the trend is in that direction.  Mid-cycle is typical of a stable or very slowly rising rate environment with liquidity not much of a concern and strong earnings growth.  This leads to higher equity prices.  Late cycle is a period of slowing earnings growth and a less liquid rising rate environment and therefore a tougher environment for equities.  Since we seem to be late mid-cycle moving towards late cycle it is easy to see how the markets may not be able to sustain a prolonged move higher right now.

Tweaks, not major adjustments.

We do share some concern that should earnings begin to fall off we may see equities come under some pressure especially in light of higher interest rates.  We don’t think this is an imminent threat, however, but are mindful of the issue just as we are about issues like global trade, North Korea (although perhaps that issue is improving in light of recent activities there) and other geopolitical concerns, and economic issues like higher interest rates, inflation, and wages.  While we strongly advise against market timing, we do advocate that investors review their portfolios on a periodic basis and make adjustments as necessary.  To that end, investors may want to make some adjustments to provide a measure of protection against market volatility but those steps should probably be just tweaks and not major adjustments.  On the fixed income side, investors may want to look for ways to take advantage of higher interest rates without adding risk or volatility to their portfolio. 

Happy Investing!

Want to learn how the market is impacting your wealth management? Contact our Wealth Management Team to discuss your specific situation.

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