Market Update October 17, 2017
I couldn’t help but to think of the Sonny and Cher classic “The Beat Goes On” last week as I booted up my workstation for the umpteenth time this year to find stocks up to start the day. More often than not, they have finished the day higher as well, with new highs being a regular occurrence of late. For the record, I believe the best rendition of this song is the live version by the Buddy Rich Band, but I digress.
Based on conversations I have been having with people, the recurring concern among investors is that stocks are overdue for a correction, and they are wondering if they should get more defensive. Based on historical data, I concur that stocks are overdue for a correction. In fact, stocks have been overdue for a correction for a long time. However, if an investor had tilted their portfolio into a cash heavy position at the beginning of the year they would have missed out on what has so far been a very positive year for stocks. One thing I have learned over the years is that bull markets can run much longer and higher than people expect. If someone gets overly conservative thinking the markets are high, and stocks continue their march higher, the investor is left agonizing over the missed opportunity and the question of when to get back in. When “the correction” eventually materializes, if it is shallow and short in nature, an investor may find themselves re-entering the market at higher prices.
Investors should be positioned appropriately in expectation that there will be market corrections. This is part of our philosophy and strategy here at GSR Capital Management. There are many ways to manage risk. Historically, high quality bonds have held up well during down periods for stocks. Academic studies typically use U.S. Treasuries when analyzing balanced retirement portfolios (meaning portfolios composed of both stocks and bonds). However, with interest rates near historic lows and Treasuries likely being in the late innings of a 35 year bull market, this may not be a good solution for managing risk, especially if interest rates begin to rise. I read a quote in this week’s Barron’s which captures part of our strategy in managing risk. David Lafferty, the market strategist for Natixis Asset Management, says: “You have to think differently. It’s more about reducing the risks within an asset class, rather than changing the asset mix.” I wish I’d said that. It is something I have been explaining to clients, but not as clearly as Mr. Lafferty so succinctly describes.
So how good has this year been thus far for stocks? The MSCI Emerging Market index is now up a whopping 27.8% through September 30th, the MSCI EAFE index of established foreign stocks is up 20.0%, and the S&P 500 index of large cap domestic stocks is up 14.2%. Bonds as measured by the Bloomberg Barclays U.S. Intermediate Government/Credit index were up 2.3% during this time.
The greatest risk to the equity markets may be an increase in inflation and the need for the Federal Reserve to more aggressively raise interest rates. The most recent jobs report showed hourly earnings rising 2.9% year over year, its highest reading this year. Wage gains can be a precursor to inflation. The financial markets implied odds of a Fed rate hike in December shot up to over 90% following the news. The markets are now likely pricing in this probability, as well as the likelihood of an additional increase in 2018. For now, the yield curve remains positive sloping, which implies that the level of rate hikes is not currently expected to kill economic growth. Corporate earnings growth expectations – which are important to support stock valuations – continue to be solidly positive over the foreseeable future.
So for now, the beat goes on. I hope you have an enjoyable fall season. Do not hesitate to contact me if you have any questions or anything I can help you with.
Glenn S. Rank, CIMA® Certified Investment Management Analyst® President
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· The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The Bloomberg Barclays Capital U.S. Intermediate Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
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