January 4, 2019 – The October issue of this quarterly letter discussed the possibility of a market down turn and how we prepare and respond to those events. As mentioned, the lengthy bull market cycle has, in fact, reversed—at least for the time being. However, the strategy we outline in each account’s investment policy is designed to withstand just such circumstances.Your portfolios are diversified with investments in many types of assets to help limit losses when any one asset class suffers a down turn. Additionally, potential market declines are factored into your investment strategy when considering the level of risk that is acceptable. The planning process also considers portfolio income needs so that suitable low-risk assets are in place to provide necessary income. In managing your investments, we do not rely on outguessing or “timing” the markets, and a sure way to lose money in a down market is to sell stocks as a general asset class during a decline.
We see the current market as an opportunity that can be leveraged to your benefit. Financial markets tend to overreact to external factors, overshooting fair value pricing on the upside and undervaluing assets on the downside. While many are selling assets, the oversold condition offers patient, long-term investors an opportunity to buy at below fair market prices. Downside risk has been reduced and the upside potential has been raised. We now view U.S. stocks as offering the best risk-adjusted return potential among all asset classes globally, and the best value, as an asset class, in years. With earnings still growing and prices having declined the last several weeks, U.S. stocks have become undervalued based on fundamentals. And, in the long run, fundamentals determine future prices. In this environment of continued low inflation, low interest rates, and an expanding economy, U.S. stocks remain the most attractive option.
Accordingly, we are now periodically investing portfolio cash into securities and sectors of the market that have been oversold. While we generally make new investments by averaging into positions over time, we shorten that time period for assets that are undervalued. This is also an ideal time for investors to add cash to their portfolios to take advantage of that the same opportunity. If portfolios are fully invested and additional cash is not available, there is still an opportunity to trim the best performing asset classes and use the proceeds to buy undervalued assets.
| Market Total Returns (including dividends) |
Oct. – Dec. |
2018 |
|
| Large Co. U.S. Stocks | S&P 500 |
-13.52% |
-4.38% |
| Small Co. U.S. Stocks | Russell 2000 |
-20.20 |
-11.01 |
| Foreign Stocks | DJ Global (ex. U.S.) |
-11.58 |
-14.35 |
| U.S. Taxable Bonds | BloombergBar U.S. Agg. Bond |
+1.64 |
+0.01 |
| Commodities | Bloomberg Commodity |
-9.41 |
-11.25 |
As in the United States, concerns over slowing global growth and trade tensions have impacted foreign stocks in developed and emerging markets. We are more cautious and selective among foreign stocks but still maintain an allocation to these markets. We expect continued—but slower—global growth in the near term.
The outlook for bonds remains mixed. While the 30-year bond bull market likely ended in the summer of 2016, bonds prices are not declining like most had predicted. With every new concern about slower global economic growth, long-term bond prices rally and bond yields decline as they did in the fourth quarter. The 10-year Treasury ended the year at a yield of 2.68%, up a modest quarter of a percent for 2018. The federal reserve has continued to raise short-term rates with the 2-year Treasury yield ending the year at 2.5%. As you can see by these yields, investors are not being well rewarded for the added risk of a 10-year bond compared to a 2-year bond. We continue to use a conservative approach, monitoring interest rate risk and favoring short maturities. When possible, we build core portfolios of individual municipal or taxable bonds and supplement with small allocations to specialty bond funds.
We diversify portfolios by including small positions in real estate and broad commodity indexes. Commodity prices have suffered as the price of oil declined and estimates of inflation in the coming year are lowered out of concern over slower global growth. Some of these factors are negatively impacting real estate prices as well, but lower long-term interest rates help to support prices for the asset class.
This quarter, our research of potential investments continued with in-office visits from JP Morgan and Goldman Sachs. I attended the Charles Schwab conference for advisors in Washington D.C where I was able to meet with several investment firms. While in the D.C., area. I also attended a meeting at the Arlington, VA headquarters of Sands Capital and visited with a portfolio manager of Touchstone Sands Select Equity, which is part of many of our client portfolios. Talking with representatives of these investment firms and learning their views of the markets and investment industry trends provides valuable connections and insights.
Although we provide an overview of many areas of the market, our focus when managing your portfolio is on your personal goal and an individualized strategy to reach that goal. We welcome your feedback and questions.