Time to Play Defense?
The stock market appears to be in a now familiar “recovery” pattern from the 12% correction it underwent in the January-April period of this year. As corrections go, 12% is “run of the mill”, about in line with the historic average for corrections of 13.3% decline. As we have said before, corrections such as this are quite normal and are, in fact, healthy for the market because they help to temper market excesses.
Currently, there are some interesting internal dynamics going on in the stock market: hyper-growth stocks (or “FANG” such as Facebook, Apple, Netflix, Google) appear to be taking a breather after carrying the market for some time, in fact years. Some market pundits are of the opinion that if these hyper-growth stocks falter, it is a bad sign for the market. We disagree for several reasons: 1) there are many other sectors of the market, particularly industrial, financial and energy sectors, that have underperformed and we believe may be in a better position to take over market leadership; 2) we believe many of the hyper-growth stocks have strong long-term fundamentals and while as a group, could underperform for a period, they ultimately have superior long-term growth prospects which should help support their valuations (and stock prices) over time.
The bond market is currently in a defensive mode due to rising interest rates. Bond prices move inversely with interest rates and we expect the bond market to remain in a defensive mode for some time, thereby keeping total returns for bonds below the long term averages. We still need and use bonds for diversification purposes because bonds prices have historically risen when stocks decline, particularly in a bear markets. That said, we do expect returns on bonds to be below the long-term averages for the foreseeable future.
Do we see now as time to get defensive on equities? The answer is no. Underlying economic fundamentals remain excellent: employment is strong; workers’ incomes are rising; consumer and capital spending remain strong; and the tail winds of lower corporate tax rates and immediate expensing of capital investments should all help to sustain the current economic recovery much longer than many pundits currently project. All of this positive for corporate profits, which are the primary driver of stock prices. And with respect to concerns about the much-discussed Fed raising interest rates, we fully expect this will continue; however, we see it 1) as a positive because it is helping to normalize interest rates; 2) we believe the Fed will not accelerate rate increases; 3) the rate increases are sign of a healthy economy; 4) the Fed Funds rate is still well below the historic relationship to nominal GDP, which means monetary conditions are still no where near “tight”.
Concept of “inherent defense”………..So does this market analysis matter to your portfolio? Yes, primarily in the sense that as fiduciaries and managers of your money, we need to remain vigilant in monitoring market fundamentals as it pertains to investment strategy. But remember that your portfolio is diversified across nine asset classes, including three in equities and three in bonds. Holding multiple asset classes helps to mitigate portfolio volatility and deliver higher risk-adjusted returns. In addition, your portfolio is allocated across these nine asset classes in a way that provides necessary growth for your financial plan strategy while keeping risk to a minimum; in other words, if your financial plan shows that you can achieve your goal with a less aggressive allocation, we believe it is prudent to invest in the less aggressive allocation in order to mitigate portfolio volatility.
So, while we may not believe it is “time to play defense” with respect to equities, remember that our strategy of allocated portfolios, “due diligence” in the form of our quarterly investment strategy meetings, and quarterly rebalancing all act to provide a level of “inherent defense” in your portfolio that should help to mitigate risk and volatility when markets do become more turbulent.
Vice President, Research