We can definitely see in the chart below that the month of May has seen the market move higher, and that has been a welcomed benefit to all of us as investors. What we need to also be aware of is that overall the market is still trying to shrug off the motivations for the larger drop in stock prices, which started in very late January. While that drop ended about a week into February, that larger decline in prices fully supports the wisdom of markets, “Stock always lose money faster than they make it.” This short-lived drop pulled market values down to where they were in October 2017, lopping off almost 5 months of growth in less than 8 days.
May reinforced that volatility is not going back into hiding any time soon. Markets are having a bit of a hard time shaking off the big pullback which came to life in the early days of February. We are now in the seasonally softer side of the markets and some investors are getting nervous and pulling out of stocks and stock portfolios. Seasonal jitters can really get to investors who are already nervous.
As of Late.
Essentially, risks showed up at the end of January and continued into early February. Not crazy risk, not abnormal risk, but it was actual “normal risk” that returned to the markets. The only “crazy” thing about it was that so many had forgotten about risks being normally present in markets since it had been virtually non-existent for the 15 months prior to the end of January. It was an “out of sight and out of mind” setup for so many, Now the hangover from that time has been a market which seems to have taken a liking to risk-less investing and investors now seem to be more nervous at most every squeak and rattle markets make. Even though there is plenty of risk floating around in several places across both stock and bond markets, risks seem to be spooking people more and more.
S&P 500 Movement for March, April & May.
We are seeing some “rotations” in the types of stocks that are performing well. For much of 2017 and into early 2018, “large cap growth” stocks (think about the DJIA) were the stocks leading the market. If we focus on the month of May, DJIA stocks grew the least and “small cap stocks” lead the way, followed by “mid cap stocks”. This has been true for the last several months, and was something we discussed in our November newsletter. As we saw this and to more toward a more effective and efficient portfolio, we made initial changes to our stock portfolios by adding small and mid cap holdings initially at the end of January. We also added more small cap equity exposure during the month of May, which helped lead the broad market indexes (DJIA, S&P 500, NASDAQ, Mid Cap 400 & Small Cap indexes) by nice margins during this month.
What we have also seen as an outcome to a struggling market and to the presence of perceived risk(s) in the U.S. stock market is some investors are becoming skittish and stepping away from U.S. stocks and U.S. stock based investments (ETFs, mutual funds and the like). Many investors have been pulling money out of stock-based U.S. investments and have been pushing large sums of money into foreign-based investments. If we look across the globe, it is hard to find countries which are anywhere close to outperforming the U.S. over the last 3 months, 6 months, and the last 12 months. This under performance across the globe is tied to how the economies of many countries are doing. If we simply look at the performance across the globe of the 45 largest stock markets, the U.S. is performing better than 75% of all country markets whether we measure over 90 days, year-to-date and a one-year cycle.
We are definitely not saying ALL is well in the U.S. markets, but currently there are some definite strong points in the U.S. economy (Capex spending, Taxes, Employment, Manufacturing, Big share buybacks). As we look across the globe, there are certainly many more problematic areas for international markets than anything we might see in the U.S.. Italy has been a mess dujour for the last three months—not having a sitting government at the helm of a country who has been trying to shake off its financial woes dating back to 2010. In concert, Greece still has large issues from the beginning of this decade, as well as Spain and a host of other European countries. We have noted in some of our most recent newsletters that even Germany is in a bit of a downtrodden slump, and being the historical leader in Europe, there is no heir apparent in Europe if Germany really loses its economic footing ( see Germany in April). The economic (and therefore market) struggle is widespread across Europe, South America, Australia, The Pacific Rim, and Africa too.
The Long-Term View.
While no one has been impressed with the returns of the U.S. markets (or even largely global markets) so far this year, keeping the longer-term market performance in view is critically important. So often when I meet with potential trustees, families and clients, their assumptions about what markets have been delivering historically seems to be askew from the realities of actual returns. I am baffled by the assumptions some individuals have concerning long-term market returns, particularly with the information so widely and easily available.
It seems some may be thinking of the “go-go” years of investing. If you look at the period of 1980 – 2000, the S&P 500 averaged double-digit returns for that 20-year cycle. But if you look at the 20 years prior to that, 1960 – 1980, the returns were less than 2%/year after adjusting for inflation.
The S&P 500, over the longer-term, has not generated very healthy returns for those who simply “buy and hold” the market. It seems that though there are some individual years with great returns, adding in those years with no return or negative returns can actually weigh down the longer term returns quite heavily, as shown in the chart below. All returns shown below are adjusted for inflation.
10 Years 15 Years Since 2000 20 Years
S&P 500 Ann Ret. 5.76%/yr. 5.16%/yr. 1.41%/yr. 2.36%/yr.
(w/dividends included) 7.46%/yr. 7.25%/yr. 3.32%/yr. 4.24%/yr.
As displayed in this chart and using the Rule of 72, we can easily see that buy and hold stock market returns since the beginning of this century have been non-inspiring. In this period of just over 18 years, S&P 500 returns would mean your investment would take between 21 and 51 years just to DOUBLE if you bought the market and held on tight.
The volatility of the S&P 500 has had a strongly negative impact on stock returns for quite some time. Illustrated in the chart below, you can see that it took 18 years for the S&P 500 to finally catch up to the return of U.S. 30-year government bonds since the beginning of this century! The amount of risks buy and hold investors have taken to try and catch up to these bonds is truly amazing.
U.S. Government Bonds vs S&P 500 since the beginning of 2000.
It is essential for an investor to stay abreast of the risk(s) they are constantly taking. . Is the risk you have greater than you want or need? How much risk one wants to take should be determined prior to investing, rather than during the investment cycle. When markets are going up, most people just sit back and enjoy the ride. They are often unaware that risk is rising too, sometimes faster than one might think.
The goal is to not be caught off guard when risks arrive.
We remain watchful.
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Lending rates are still extremely low by historical standards.
Man 1 - Bank 0
A few years ago I saw a most hilarious Broadway show! It is a one man show and it is a real life story. The best part of it is that the person who lived out this story is the actor in the show. It has played all over, NYC, LA, London, Paris. Pretty amazing. If you ever get a chance to see it, GO! If you have ever been frustrated by the actions of a bank, GO! You will love it. Its a real story about how at least one time, the little guy won! Here is a short clip of short segments from the show, https://www.youtube.com/watch?v=5jfRLIuqs6o. The clip really doesn't give you the best perspective on the show but might be good for a laugh or two to watch the clip. The name of the show is, "Man 1, Bank 0".
Now, Bank 700 - Customer .1?
Recently as I was thinking about the status of banking here in the U.S., the name of this Broadway show came to mind, actually in reverse now it seems. With the bank getting all the points and the consumer getting zero.
Here is what brings this all to mind. For the past year and a half basically, short term interest rates have been moving higher and higher. These short term interest rates are the only interest rates which the Federal Reserve has direct say so over what they will be and they have been raising them quite regularly as they stated that they would. This is called the Federal Funds Rate and it has gone from .25% to 1.75%, a whopping 700% increase. Out of all of this we now see that the 13 week Treasury Bill has a YIELD which has gone up 38 fold! Yes, up 3800%!
Click to Enlarge
So, during the previous 18 months the Federal Reserve has raised what banks charge each other to borrow money. If you were a bank and you needed to borrow money, would you rather pay .10% interest OR pay 1.75% interest?
What banks are doing now is really what they always have done but now to me it seems even more egregious. They are borrowing from their depositors, pretty normal, and currently that is at about 0.10%. Then again, as normal, they charging customers from about 4.5% in interest to as much as 18% in interest on the various types of lending products and loans they have in place.
For me, the even more egregious part is the paltry rate which banks are paying their depositors. Now the rate has been really low for a long time but bank rates, set by the Federal Reserve were extremely low too so I was not as concerned about the rates the bank was paying depositors since they too were getting low rates. But, as rates have been rising a LOT as stated above, my concern here is that they are only going up for the banks and they are NOT going up for the bank customers!! To me, this is a large problem. I think if you wanted to impact your bottom line and get a higher interest rate from an FDIC bank, you could easily find one paying a much higher rate than the national avg.
We currently have holdings based on the following in the six models we use most;
Small Cap Index/Russell 2000
And we also now have a small portion in a money market.
S&P 500 Index
Mid Cap Growth Index
Electronics Sector Index
S. Korea Index
Precious Metals Index
Japan Nikkei 225 Index
India Nifty 50 Index-Our Newest Position
High Yield Bond Index
Long-Term U.S. Government Bonds
Tax-Free High Yield Index (Largest % of holdings in this model)
U. S. Government Bond Index