Third Quarter Review
US and European equities had the worst quarterly performance since 2011. The markets were rattled by slowing growth in China, uncertainty over Federal Reserve monetary policy, and worries about corporate earnings. The S&P 500 stock index returned negative -6.44% in the three months ending September 30, closing at 1,920.
On Monday, August 24, the Dow plunged 1,089 points before scratching its way back to a loss of 588. The plunge continued on Tuesday, then the markets recovered sharply over the remaining three days of the week. Investors who held on were rewarded; those who sold in a panic paid dearly, and quickly.
Looking at broad market indices, the US equity market outperformed both international developed and emerging markets. The MSCI World ex-US index returned negative -10.6% and the MSCI Emerging Market index returned negative -17.9%. US REITs returned positive 3.9%, outperforming the equity markets.
Commodities were broadly negative. The Bloomberg Commodity Index Total Return returned negative -14.47%. The worst damage was to the energy sector with WTI crude oil dropping -27.39% and natural gas shedding -15.03%.
Many investors were reminded during the period of the reasons to hold fixed income securities. Treasury prices rose as yields declined, driving returns on Barclay’s US Aggregate Bond Market Index up 1.25%. Citigroup’s Global ex US Bond Market hedged to the US dollar returned 2%. The yield on the 5-year Treasury note dropped 25 basis points to end the quarter at 1.38%. The yield on the 10-year Treasury note decreased 27 basis points to end the quarter at 2.06%. The 30-year Treasury bond fell 22 basis points to finish with a yield of 2.88%. Yields on the short end of the curve were relatively unchanged. Short-term corporate bonds returned 0.30%, while intermediate-term corporate bonds returned 0.71%. Short-term municipal bonds returned 0.74%. Intermediate-term municipal bonds returned 1.68%.
The value effect was negative in the US, developed ex US, and emerging markets. Small caps outperformed large caps in the non-US and emerging markets, but underperformed in the US. The US dollar appreciated against most currencies.
In conclusion, passive investors who stayed the course during Q3 were rewarded. Since the bottom in August, US markets are up 7.25%, international markets have climbed 8% and emerging markets have surged 11.4%.
How to respond to a “correction”
With hindsight, it’s easy to know when you should have sold equities. Those who lived through the bear market of 2007 – 2009, when the markets lost over 50% of their cumulative value, can pinpoint the day the market turned, and when it began to recover.
Foresight is trickier, because every market downturn is different in its severity and duration. If you are tempted to time the market, the tough part is getting your timing right. At best it’s a guess. To avoid short-term losses you must be willing to forfeit potentially greater long-term gains. This is perhaps the toughest lesson any investor has to learn: refraining from choices that could cause irrecoverable losses.
Stock prices have declined 10% or more on 28 occasions between January 1926 and June 2015. All the big declines—20, 30 or 40 percent or more—began by crossing the threshold of 10%. Some investors believe this 10% line is the time to sell, marking a “correction” that may signal a bigger downturn. But no one can know the optimal time to buy back in. As the late, great Yogi Berra said, “It’s tough to make predictions, especially about the future.”
According to Westin Wellington in a recent DFA article (“Should Investors Buy After a Correction?”), research shows that US stocks have typically delivered above-average returns over one, three, and five years following consecutive negative-return days resulting in a 10% or more decline. Dramatic changes in security prices may be a sign that markets are working as they should, self-correcting when needed. Bottom-line, investors who accept market fluctuation may achieve greater long-run success.
Beware the siren call of alternative strategies
In uncertain times you’ll notice a proliferation of new investment strategies being touted by Wall Street…the latest being “smart beta.” It’s just like passive investing, only better! Or so the advertising would have you believe.
If you are considering alternative strategies, ask yourself, what’s the bait? Historically high stock and bond valuations and recent volatility across global equity markets have increased investors’ concerns about future returns and downside risk. Amid the clamor, smart beta marketers are bombarding investors with increasingly complex strategies, each claiming to improve expected rewards and reduce risk by broadening diversification with something new. That “something new” may employ techniques like short selling, leverage, derivatives and timing, or other twists layered over principles of passive investing. Yet each new strategy involves less investing, more trading and increased opportunities for the financial sector to enrich itself at your expense. Wise investors know there is no fountain of youth (if there were, we’d all be drinking from it).
If you haven’t read our recent blog about smart beta, please take a minute to acquaint yourself with it and learn why we advise caution. Click here
to learn more.
Keep it simple
The large majority of investors will be better off staying away from smart beta, market timing and other “outsmart the market” strategies. Our advice is to stick to a simple, historically proven and balanced approach to investing with a portfolio of low cost index funds. Tailor asset allocation to your personal risk tolerance and investment objectives, diversify broadly, have realistic expectations, maintain a long-term perspective and keep your costs down. When the market hiccups, take a walk and tune out the talking pundits. Sometimes doing nothing is the best way to get ahead in the long run.