Monthly Outlook: May 2018
Global stocks have now stalled for the past five months as investors digest conflicting inputs. On the positive side, corporate earnings continue to move higher, but so do interest rates (a negative). Consumer confidence and employment are high, but so are valuations. And although the S&P500 is exactly where it was five months ago, there’s been a lot of volatility and conflict along the way. History shows us that stocks don’t move sideways for long. We expect resolution soon and for a sustainable trend to develop. The question is “which direction?” Will the 9-year uptrend continue or are we about to enter a correction? It’s also possible that the answer is “both.” Some asset classes could trend higher while others sink. That’s why we’re always vigilant and managing the mix in our iFolios. We’ll discuss that in more detail later, but let’s review the markets first.
U.S. stocks (S&P500) gained a modest 0.5% in April but are down 0.5% for the YTD. International stocks (FTSE All-world ex-USA) gained a similar 0.6% in April and are barely positive for the year, up 0.2%. Bonds (Barclays Aggregate Bond Index) continue to suffer from interest rates that are creeping higher. Bonds lost 0.8% in April and are down 2.4% YTD, even including interest. The benchmark for a 75%/25% stock/bond mix is now fairly flat at -0.8% YTD.
Managing the Mix
We look at investment portfolios as stored up future spending. When you have money, you can either spend it or save it for later. If you save it, you want to know that 1) you’ll still have it when “later” comes and 2) that it will buy the same amount of “stuff” in the future as it does today. That is, the savings has to at least keep up with inflation and, hopefully, maybe do even better. Our iFolios strategy would be classified by Morningstar and other rating agencies as an “Active Allocation strategy using index funds.” For every asset class, every index fund in our arsenal, we ask “Is it better than cash?” If it is, if it remains above its long term trend line, then we stay fully invested. If it isn’t, we trim/sell it and raise some cash. Secondarily, we also compare each asset class, each index fund, to each other and ask “how is this index fund performing relative to another index fund?” If short term bonds are better than long term bonds (which is the case now), we’ll tilt toward short term bonds. If international stocks are better than U.S. stocks, we’ll tilt towards international stocks. Make sense? This is how we manage to 1) make money and 2) outperform by tilting toward the best assets.
Since the 2008 financial crisis and severe stock market correction, we’ve experienced one of the longest recoveries and rallies in 100+ year history. The current recovery is now 107 months old, and second longest behind the 120 months recovery that ended in 1991. For most of this recovery, almost all assets have been better than cash, so it’s been easy to make money; just stay invested in something! As for relative returns, stocks have outperformed bonds. US stocks have outperformed international stocks. And riskier, high growth sectors like technology have done better than the broader market. These are the traditional relationships that many investors follow by default. But going forward, we’re starting to see some shifts. In bonds, short term bonds and international bonds are outperforming long term and high yield bonds. In stocks, international stocks, particularly European and Japanese stocks are starting to outperform U.S. stocks, generally. Of the ten sectors in the S&P500, half are still trending higher but the other half are not beating cash and should be sold (including Industrials, Materials, REITs, etc.). The point here is that “managing the mix” has never been more important. The easy period of “buy everything and anything” seems to be behind us.
Our iFolios strategy is completely focused on constantly and actively managing the mix of our clients’ portfolios. Today, we favor short term bonds over longer term bonds. We’re selective in our stock allocation favoring US growth, Europe, Japan over US value and Emerging markets. It might also surprise investors to know that Commodities are outperforming the S&P500 and should be included in diversified portfolios. If you’re not an iFolios investor, it’s time to let us review your portfolio, weed out the losers, and add some winners.