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.
Bob Toomey,
Vice President, Research
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