The stock market has rebounded significantly in 2019 despite on-going economic and political uncertainty. As always, as we begin Q2 it’s important for long-term investors to stay disciplined and maintain perspective.
After all, the first quarter marked the tenth anniversary of the market bottom on March 9, 2009, and the tenth anniversary of the economic trough in June 2009 is also fast-approaching. While bull markets and business cycles don’t have pre-determined expiration dates, it’s a good time to reflect back on how far we’ve come.
In the first quarter, the S&P 500 index rose 13.6%, while the Dow Jones Industrial Average and NASDAQ increased 11.8% and 16.8% respectively. The 10-year Treasury yield fell in the final weeks of the quarter to 2.4%, the lowest level since the end of 2017. Global stock markets also rebounded with developed market stocks rising 10.2% in U.S. dollar terms and emerging markets gaining 9.9%. With this backdrop, there are a few key principles for long-term investors to keep in mind.
First, the last three months are a reminder that staying invested for the long run requires taking the good with the bad. Even though last year’s market drop and this year’s rebound have felt like a roller coaster ride, the S&P 500 index is now only 3.3% below last year’s peak. Investors who stayed the course would have weathered the storm. What’s more, the stock market is up nearly 9% with dividends since the beginning of 2018 and almost 32% since the start of 2017.
Second, what matters for long-term investors is constructing diversified portfolios based on market and economic fundamentals. While the prices of stocks and bonds can swing wildly on a daily, monthly or quarterly basis, they tend to follow the business cycle over the course of years and decades.
Third, it’s important for investors to see past short-term market noise. A tremendous amount of the coverage and discussion on markets is essentially trivia. How did the market perform on this same day twenty years ago? Did the market cycle begin in 2009 or was it really 2013? How will some political event affect markets this week? This is the junk food of the investment profession. Like junk food, it serves a purpose and is fine in moderation and in the right context.
However, the real nutrition comes from holding balanced portfolios that help investors achieve their financial goals. Whether the market performs better on Mondays or Thursdays, or in January versus December, may be interesting and possibly provide secondary value, but it isn’t the most important thing.
1. Keeping perspective on the markets is as important as ever
Stock Market Returns in Perspective
Stocks have rebounded significantly in 2019. Combining last year’s market pullback with this year’s recovery puts the S&P 500 only about 3% from the all-time high. Since the beginning of 2018, the index has increased 6%. From the beginning of 2017, it’s risen almost 27%. These are healthy returns, despite interim market volatility.
We’re later in the business cycle and corporate earnings are decelerating. Still, history shows that those investors who can stay patient and invested are in a better position to reach their financial goals.
2. Global stocks have rebounded in 2019
Global Stock Market Performance
The rebound in stocks isn’t just isolated to the U.S., but is a global phenomenon. Both emerging and developed markets have also bounced back from last year’s pullbacks, in both local currency and U.S. dollar terms. What’s more, these markets are generally much cheaper than U.S. stocks, especially if global growth stabilizes or even re-accelerates.
3. The Fed is being patient
Global Central Bank Balance Sheets
As has been the case over the past decade, a major reason for the market recovery is central bank policy. The Fed has signaled that they will be patient with their monetary policy decisions. Specifically, they have put their policy of rate hikes on hold and have announced that they will stop shrinking their balance sheet later this year.
A central bank’s balance sheet grows when they purchase assets – in the Fed’s case, Treasuries and Mortgage-backed securities. Thus, its size is a measure of stimulus by a central bank. The chart above shows that the Fed had begun shrinking its balance sheet by letting assets mature and roll off, even as other central banks have continued to increase stimulus. The fact that the Fed had put these policies on pause is a reflection of uncertainty around future economic growth.
4. The yield curve is in the process of inverting
As a literal measure of interest rates across maturities, the yield curve is an important tool for understanding how interest rates relate to one another. We can easily see the relationship between short-term rates on the left, primarily controlled by the Fed, and long-term rates on the right, which are affected by the economy and influence mortgages, for instance.
However, the yield curve also tells us much more. As a whole, the shape of the curve provides clues as to how far along we might be in the business cycle. Not only has the yield curve been flattening for some time now – a sign that we’re later in the expansion – but has begun to invert.
Yield curve inversions are a process, not overnight events. Historically there have been anywhere between 9 to 23 months between a full yield curve inversion and the onset of a recession. During that time, markets can still perform well.
Regardless, the key takeaway isn’t to try to time a recession but to position appropriately. Additionally, the yield curve has not yet inverted based on the most common measure using the 10-year and 2-year U.S. Treasury yields.
5. We are nearing the tenth anniversary of the economic expansion
Leading Economic Indicators
This coming June will mark the tenth anniversary of the economic trough during the global financial crisis. Much has happened in the past ten years, but with the benefit of hindsight, it’s easy to see that the U.S. economy has grown slowly but steadily. Where will it go from here?
Like many indicators discussed above, it’s clear that we’re in the later stages of the cycle. Leading economic indicators, which look at a variety of forward-looking economic factors, corroborate this view.
However, like the yield curve, this is a process, not an overnight event. Similar to the yield curve, leading economic indicators may decelerate over time before finally turning negative. Even once they turn negative, there can be some time before the actual onset of a recession.
Additionally, there have been many false positives, even just in the last several years. Thus, it’s important to stay balanced across all market and economic scenarios, rather than try to perfectly time a recession.
6. The U.S. debt continues to rise but is still manageable
Holders of U.S. Treasuries
One source of investor concern is the level of the U.S. debt. While the patient is sick, it’s most likely that the patient is not yet in critical condition – as it was during the financial crisis. It’s also important to understand how the debt is measured and how its composition has changed over time.
The chart above shows who holds U.S. Treasuries. By far the biggest holders are the U.S. government itself and other domestic institutions and individuals. The best way to measure total debt is actually to remove the portion held by the government since this is essentially moving money from one pocket to the other.
At the moment, all other countries account for about 28% of the ownership of Treasuries. This has been growing over time, especially with large and fast-growing countries like Japan and China, respectively.
It’s important to distinguish between our policy priorities and citizens and voters, and our objectives as investors. The question of whether this situation is sustainable, and what should be done about it, is an important one that should be debated. However, from an investment perspective, positioning one’s portfolio based on these trends can be difficult and risks missing out on more important opportunities.
7. Stay invested
Stock Market 10-Year Rolling Returns
A lesson learned time and time again in the markets – over the last three months, the last ten years, and over the past half century – is that staying invested is the best course of action for long-term investors. Of all of the investment principles required of disciplined investors, this is perhaps the most important. Staying invested in an appropriately diversified portfolio is even better.
The chart above shows rolling 10-year returns since World War II. While these returns can vary significantly over time, there have been very few instances when investors were under-water over these long time frames. And even when they were, markets tended to rebound shortly thereafter. Investors who permanently exited to cash would have done so at exactly the wrong times.
Of course, longer time horizons look even better. This is why it’s important to ignore as much of the market noise as possible and to focus on these returns instead.