Fall 2018 Market CommentarySubmitted by Affiance Financial on October 9th, 2018
October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February. — Mark Twain
With three-quarters of the year in the rearview mirror, we are looking at a bifurcated global stock market. U.S. stocks have racked up positive performance year to date, led by technology stocks. A significant portion of the year’s U.S. market performance has been realized during the past three months. Performance has been primarily attributable to higher corporate earnings (in large part because of tax reforms), greater economic growth, higher oil prices, and accounting changes. Unemployment continues to remain low and inflation, while increasing, is still modest by historical standards. However, it has been a much different story for international stocks. Both international developed and emerging market stocks have declined this year, with emerging markets down by about 9% and developed markets down by about 2%.
Bonds have also had a negative return for 2018, largely due to the Federal Reserve increasing interest rates. Putting this together, a globally diversified portfolio made up of both U.S. and international stocks and bonds is going to have a substantially flatter return than U.S. equities this year. Results for 2018 stand in stark contrast to last year, when emerging markets soared, international stocks outperformed U.S. stocks, and bonds posted solid gains. “Diversification is always having to say you are sorry,” says Brian Portnoy. These words have never been more true than during this year.
A large part of the challenge is that we are living in “the punch bowl economy.” Since 2007, our economy has been artificially stimulated by both Central Banks and the Federal Government — they have been spiking the punch to get the economic party going. Today, the Federal Reserve continues to shift its position to a more restrictive monetary policy, as it raises interest rates and continues quantitative tightening. We expect the Federal Reserve to raise interest rates one more time this year, and they likely will continue to raise rates during 2019. This action is effectively removing punch from the punch bowl to slow down economic growth, moderate potential inflation, and make sure the party does not get out of control. The problem is that the Federal Reserve has never been successful at executing a soft landing. It is reasonable to suggest that at some point in the future, they will raise rates too far. And as everyone knows, when the punch is gone, the party ends.
As such, we believe that 2019 asset class performance will be significantly different than 2018, as corporations will be facing higher interest rates and will no longer have the one-time stimulus from tax reform. U.S. corporations will have a harder time meeting expectations for gains in 2019 after 2018’s stellar performance. For this reason, we continue to strongly believe that diversification, in both stocks and bonds, is a sound long-term strategy. We continue to like international stocks, as valuations appear to be more attractive than U.S. stocks and trade wars are likely to be resolved in time. In addition, higher interest rates, which are initially painful to bondholders, will benefit savers over the long term. Finally, diversification allows for having safe places for liquidity when cash is needed, which is critical for rebalancing during a potential market correction as well as withdrawing for personal needs.
While the absolute returns for globally diversified portfolios have been disappointing this year, we continue to believe that this strategy will benefit investors over the longer term. It is the classic tale of the hare and the tortoise. When it comes to markets, the hare tends to quickly follow what has done well, and many times winds up with less than satisfactory results, while the tortoise slowly and steadily wins the race.
As always, we continue to be loyal stewards of the money you have worked so hard to earn.
Your Affiance Financial TeamThe views represented in this commentary are not meant to be construed as advice, testimonial or condemnation of any specific sector or holding. Investors cannot invest directly in an index. These unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Past performance is no guarantee of future results. To discuss any matters in more detail, please contact your financial advisor.
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