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3rd Quarter Market Review: Looking Beyond What Is Right In Front Of You

As a son to owners of a motorcycle dealership, it’s no surprise that I grew up riding and racing dirtbikes and became quite good (a legend in my own mind, respected by some, but now pretty slow compared to the top riders). Over time and having endured my fair share of bumps and bruises, I learned two primary lessons for riding fast through the woods. The first lesson was to look ahead… way ahead, down the trail, even though your eyes really want to look right in front of your front fender. One of the main reasons for this simple technique was that when going fast, it is generally too late to react to whatever is directly in front of you. If you see it a long way off, you have a chance to reduce speed, change direction, etc., but if it’s right in front of you, it’s too late. This sounds simple but goes against your human nature. The second and equally important tip was to have good body positioning on the motorcycle, most often standing on the footpegs (not seated), well balanced, and in the middle of the bike. The main reason for this is that often what causes a wreck is something that catches you by surprise, that you didn’t see, like a bump, rock, or stick in the trail. If your body positioning is good, you and the bike can react in the best possible way. Of course, if your body positioning is poor, you are wholly dependent on “seeing everything” and responding in time, which of course is impossible, causing wrecks to be much more likely.

I mention these tips because they relate very closely to a few basic investment principles that are very timely today. “Looking ahead”, even “way ahead”, is always wise in investing and, as in motorcycle racing, what is right in front of you is already impacting you. Economic and market data can provide a view into the future, but we know that uncertainty exists and surprises are possible (if not likely). With that in mind, good portfolio positioning, being properly diversified, is our best remedy for the uncertainty that exists. We know we can’t predict every event that could occur or react quickly enough to completely avoid issues, but we can absorb many impacts with proper portfolio positioning. The following summarizes our views of current market activity, a look ahead, and discussion of portfolio positioning.

Source: Blackrock Benchmark Returns Comparison Sept 2018/ Bloomberg

 

US Stocks

After a terrific 2017, I think most investors were feeling somewhat relieved just to see positive returns continue as we passed mid-year, especially after a rocky start to the year. As we enter the 4th quarter, 2018 has continued to impress with the major indices continuing to climb. We are now 111 months into an economic expansion, which could very well beat the record if it continues through next July. The S&P 500 returned 10.56% year to date thru the end of the quarter. Performance across the sectors has been somewhat mixed, with growth-oriented sectors like technology, healthcare, and consumer discretionary stocks up substantially (20.63%, 16.63%, and 20.64%) while value-oriented sectors like consumer staples, financials, telecommunications, and utilities have much lower returns (-3.34%, 0.09%, 0.75%, 2.72%). I would remind people that “trees don’t grow to the sky” and most extreme outperformance doesn’t persist, so don’t give up on value stocks or think that growth stocks are the only place to be. In general, corporate profits have been very strong with year-over-year earnings growth of 27% and record high-profit margins on the S&P 500. Analysts expect these great earnings results to continue through 2019. Smaller companies represented by the Russell 2000 index returned 11.51% and continued to benefit from deregulation and tax reform. In our last quarterly market review, we highlighted the fact that trade skirmishes were a risk to continued growth. While not completely settled, many agreements are underway, with China being the last major country still playing hardball. Trade agreements will continue to be important to not only economic stability, but also market sentiment. What do we do in light of these good results over the last few years in U.S. markets? Be thankful for the good returns, continue to look ahead for hazards, rebalance portfolio allocations on a regular basis, and maintain a portfolio positioning that recognizes that surprises and unforeseen obstacles can pop up quickly.

International Stocks

2017 was a great year for developed international stocks, outpacing the U.S., but trade fears and U.S. dollar strengthening has weighed a bit on these markets so far in 2018. The EAFE index has returned -1.43% thru the end of the quarter. From a valuation perspective (which long-term is very consequential), the gap between U.S. stocks and their foreign counterparts is the widest it has been since 2009 (according to Bank of America Merrill Lynch), but there is no immediate catalyst to cause a switch in investor sentiment. As John Maynard Keynes once described the market as a beauty contest, you don’t pick who you think is most beautiful, but rather who you think other people (the consensus) will pick. In today’s environment, current market sentiment favors domestic markets for good reasons, but we know these opinions can change quite quickly and that diversification remains critical.

Emerging Markets      

Last quarter was the start to what has become a tough period for Emerging Market stocks, despite a rosy global backdrop. Emerging market troubles stem from several country-specific issues, which were exacerbated by rising U.S. interest rates, rising oil prices, local politics, and trade tensions. As we highlighted last quarter, even though these assets are volatile, they still represent an attractive long-term investment with strong fundamentals, but will require that other investors return to the mix and not exacerbate the issue with capital flight. The Emerging Markets Index ended the quarter down -7.68% for the year. To be clear, worldwide economic growth is largely dependent on many emerging markets and their large populations as they continue to develop. This growth (which is ~twice the rate of developed countries) will provide markets for all companies to serve, including companies (stocks) located in those countries. We believe it is important to maintain allocations (although small) in these markets.

Bonds

The Federal Reserve once again raised rates 0.25% in September, the third hike this year. In their statement, which is carefully studied by market participants, all language remained positive on the U.S. economy and the only change was the removal of the phrase “the stance of monetary policy remains accommodative.” Since the Fed has achieved its target of full employment and stable prices, it appears to be sticking to a course of slowly raising rates through 2020, or until something changes (inflation rises, the economy slows, markets falter, etc.). The goal appears to now get the Fed Funds rate to a level at which it has plenty of dry powder to stimulate the economy by the way of rate cuts, if/when we have an economic downturn. Every rate increase has a two-fold effect: the immediate one, which is lower prices for current bonds, and the lasting one, which is higher yields. Many bonds now offer yields higher than dividend yields on stocks and this trend should continue. Bridgeworth has always felt that bonds play a critical role in diversification, and while it remains a tricky asset class in the face of more expected rate increases, the universe of bonds and fixed income strategies allows us plenty of room to diversify this much-needed investment. When the next downturn occurs, investors will most likely be really thankful for the bonds in their portfolio. The U.S. Aggregate bond index ended the quarter -1.60% for the year, the short-term (1-3 year credit) bond index 0.73%, and the high yield bond index returned 2.84%.

Summary

While dirtbike riding tips probably aren’t helpful for most Bridgeworth investors, the parallels to the investment world can’t be emphasized enough. Media reporting will suggest a wide array of bad ideas to deal with an uncertain future. Our investment committee, armed with economic and market data, a grasp of market history, and a commitment to our investment principles, knows that focusing our attention ahead and maintaining proper portfolio positioning is critical. We can help build portfolios that provide a more enjoyable ride while minimizing risks no matter which way the trail turns. We appreciate your trust in us as a steward of your capital and allowing us to help you navigate whatever trails lie ahead.

Zach Ivey, CFA, CFP®

Chief Investment Strategist

1-772750.1018

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 5, 2018, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Bridgeworth, LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not ensure against market risk.

Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass.

Reliance upon information in this material is at the sole discretion of the reader.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments.

The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments.

Any securities, indices, and other financial benchmarks shown are provided for illustrative purposes only and reflect reinvestment of income, dividends, and other earnings. They do not reflect the deduction of advisory fees. Investment products are subject to investment risk, including possible loss of the principle amount invested. You cannot invest directly in an index.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.

The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa. Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.

The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.

Barclays 1-3 Year Government Bond – Barclays 1-3 Year Government Bond Index is a market value-weighted performance benchmark of investment grade government and corporate bonds with maturities of one to three years.

The Markit iBoxx USD Liquid High Yield Index is designed to reflect the performance of USD denominated high yield corporate debt. The index rules aim to offer a broad coverage of the USD high yield liquid bond universe. The Markit iBoxx USD Liquid High Yield Index is rebalanced once a month at the month-end (the “rebalancing date”) and consists of sub-investment grade USD denominated bonds issued by corporate issuers from developed countries and rated by at least one of three rating services: Fitch Ratings, Moody’s Investors Service, or S&P Global Ratings.

Neither Bridgeworth nor its content providers are responsible for any damages or losses arising from any use of this information.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing.