First a quick note, I’m honored to have been selected as a finalist for the San Diego Business Journal’s 2017 Veteran & Military Entrepreneur of the Year Awards. I’m honored to be in the company of some fine men and women who are making a difference.
With new market highs, many investors want to try and capture their gains by selling stocks or delay any future investing into the market in an attempt to miss the inevitable downturn. The sentiment is usually communicated something like this: “I’ve had all these gains and the markets have done so well. The market is at historical highs and there is so much bad stuff going on I just know the market is going to drop. Can’t I just get in when I feel better about it?”
The market will drop again at some point, in some unknown magnitude, at some unknown time, for some unknown duration. And then, of course, it will recover in some unknown magnitude, at some unknown time, for some unknown duration. But this happens every day. At any moment throughout the day, the market may go up or down. So yes, there will be market corrections and in fact these happen quite frequently.
One key to getting your mind around this is understanding that historically, the markets have gone up significantly over longer periods despite short-term market corrections.
Another key to perspective is acknowledging that trying to initiate a specific tactical investment strategy based on three significant unknown market cycle variables (magnitude of change, timing, duration) on the downside and upside, each day, week, month, year, and decade you are investing, is simply an equation that cannot be solved. Thinking back to Algebra 101, there are too many unknown variables to solve the equation. Note: There is an answer to this dilemma; it simply uses known and controllable variables.
Alas, the mind is a master at self-deception and many people still think they, or someone else, can time the market. There are usually references to actual cases where this has been accomplished, but over time the data shows these instances are just statistical anomalies — luck. And as we know, at some point, luck runs out. If you’ve heard someone say they got out of the market before a downturn, ask them if they precisely timed getting back into the market, reaping the full rewards of the positive returns in recovery. You’ll most likely be greeted with a blank stare and some stammering. Not participating fully in upturns can be more damaging to wealth building than experiencing downturns.
At the core of this debate is the following question: Do new market highs give us any indication of future market returns, thus giving us a clear strategy for timing the market? The answer is no.
History tells us that a market index being at an all-time high generally does not provide actionable information for investors. For evidence, we can look at the S&P 500 Index for the better part of the last century. Exhibit 1 shows that from 1926 through the end of 2016, the proportion of annual returns that have been positive after a new monthly high is similar to the proportion of annual returns that have been positive after any index level. In fact, over this time period, almost a third of the monthly observations were new closing highs for the index. Looking at this data, it is clear that new index highs have historically not been useful predictors of future returns.
You should have some piece of mind if your investment management includes a precise and proactive rebalancing strategy. If so, by default, you are selling higher- priced securities and buying lower-priced securities throughout market cycles without making the mistakes market timers make. This is truly a win-win scenario for investors by consistently and effectively taking advantage of market downturns and upturns as they occur.
2017 Q3 Index Review
(Table disclosures and https://www.worthpointeinvest.com/disclaimer/) performance for periods greater than one year are annualized. Selection of funds, indices and time periods presented are chosen by the client’s advisor. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results. Russell data copyright © Russell Investment Group 1995-2013, all rights reserved. The S&P data are provided by Standard & Poor’s Index Services Group. MSCI data copyright © MSCI 2013, all rights reserved. Barclays Capital data provided by Barclays Bank PLC.)
Stellar performance is the story for most third quarter indicated equity indexes. MSCI Emerging Markets led the pack with an 8.04% return for the “3 Months” period, followed by the Russell 2000 (U.S. small companies) and MSCI EAFE (international developed companies). Year-To-Date, Emerging Markets has astounded with a 28.14% return. REITs have held their own, but have lagged the other equity indexes for the quarter, with the US REIT index the lowest at 0.84%, followed by Global REITs at 2.42%
Bonds shored up well for the quarter with the knowledge that interest rates increased across the U.S. fixed income market for the quarter, with the Bloomberg Barclay’s Global Aggregate Bond Index performing the best at 1.76%. It’s only when you look at the “1 Year” numbers for two of the bond indexes that you see a slight negative return. The yield on the 5-year Treasury note increased by 3 basis points (bps) to 1.92%. The yield on the 10-year Treasury note increased by 2 bps to 2.33%. The 30-year Treasury bond yield increased by 2 bps to finish at 2.86%.
The “1 Year” equity index performance numbers are astounding, but interestingly there have been better years for many of these indices. Also, it would be a mistake to look at this data and contemplate a transition out of bonds if this goes counter to your long-term risk and return needs. The right bond allocation will most likely give you added stability in your portfolio during equity downturns and distribution phases such as retirement, as long as they are allocated correctly with respect to duration, credit quality, and global diversification.
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