Most of you probably feel like you are in the twilight zone. We started 2016 with a panic in the stock markets, with all of the news rather gloom and doom. The talking heads on TV signed the death certificate of the US stock market, and forecasted that the sky is falling. Fast forward 11 months, those same naysayers are popping champagne bottles celebrating Dow 20,000. What happened?I do not think anyone will argue that President-Elect Trump’s victory fueled the rally, which the media dubbed the “Trump Rally.” The truth is that the S&P 500 (+~9.5% YTD) began its quiet recovery run in mid-February this year. Many people watch financial news on a daily basis and benchmark their personal investment accounts against the S&P 500 index. It would be very surprising if anyone reading this has a portfolio that would be appropriately benchmarked with only the S&P 500 index.
The S&P 500 is comprised of the largest 500 (or so) companies in the US. A lesser known group of stocks, which most people own in a piece of their portfolio, is the Russell 2000. The Russell 2000 is comprised of small public companies in the US, and is up almost double (+~17%) the S&P 500 for 2016. I said all of that to say that not all stocks, or stock indices, are created equally.
Let’s talk Non-US stocks. The Trump rally is positive for US stocks, but not so much for Non-US stocks. Developed Non-US indices are actually negative (MSCI EAFE, ~-1.9%) for the year. Most financial professionals suggest that client portfolios include a globally diversified stock portfolio. A well-diversified global stock portfolio might consist of 50% US, 40% developed Non-US, and 10% Emerging Markets. The aforementioned mix would mean that approximately 60% of your stock portfolio is positive for 2016 (Emerging Markets are ~+11.3%), and approximately 40% of your stock portfolio is negative. If you are scratching your head about how the S&P 500 is up almost 10%, yet your investment account is only up 4-6%...Voila!
Since we talked about stocks, it’s only fair that we address bonds too. Bonds are likely the most underrated, misunderstood component of a proper investment portfolio. Folks get ready to throw bonds out with the bath water when the stock market is going straight up. Bonds are a critical piece of the portfolio. They provide diversification, income, and stability (or ballast, as our Chief Investment Officer likes to state).
Bonds actually deserve an entire blog dedicated to them and is outside the scope of this writing. Even more so than stocks, no bonds are created equal. Many people believe in the myth that bonds do not fluctuate in price, but that is simply untrue. Bond prices are inversely related to the movement of interest rates. To oversimplify, think of a seesaw (from your childhood)…interest rates go up/bond prices go down and vice versa, interest rates go down/bond prices go up.
Bonds started the year very strong, as interest rates on the 10 year US Treasury bond fell from 2.27% (12/31/2015) to 1.6% through the end of September. Interest rates, however, rallied post-election creating falling bond prices and portfolios. The price impact of a 1% rise in interest rates for the 10 year US Treasury bond is -8.7%. Since the end of September, the 10 year US Treasury bond yield went from 1.6% to 2.47% (12/9/2016)…almost a 1% rise.
Despite the late season volatility in bond prices, most bonds are still positive for the year. High yield bonds drastically outperformed (~+15%) US aggregate bonds (~+2.4%), while municipal (~-1.8%), also known as tax-free, bonds detracted.
If you are looking through your statements and your portfolio is up 3 to 6% since January 1, then there is solid evidence that you have a well-diversified portfolio. The best way to win is to come up with a plan that meets your goals and minimizes the amount of fluctuation in your portfolio. Timing the market is a losing game…Time In the market is how winners play. Good advice is to buy quality, diversified investment and stick to the plan. An investor that stayed the course over the last 20 years with a 60% stock/40% bond portfolio earned an annualized return of 7.2%. Investors that were too smart and tried to time the markets earned an annualized return of 2.1%.
Martin serves as a Wealth Strategist at Pinnacle Trust. He also serves as a member of the Investment Committee. You can reach Martin by emailing him at email@example.com or by calling the office at 601-957-0323.