As the world (more slowly) turns
By Kyle Tetting
The performance of stocks in May reflects growing uncertainty about the state of global economic growth. The trade war with China has exacerbated the problem, but it is unfair to blame the entirety of the decline on increased tariffs and ongoing uncertainty.
Most economists expect the trade war between the U.S. and China to reduce global economic growth by just 0.15% – 0.25% a year, with China feeling a slightly bigger impact than the U.S. As trade disputes intensify, expect those projections to increase.
And yet, for some time both the International Monetary Fund and the Organization for Economic Cooperation and Development (OECD) have been reducing estimates for global growth. The IMF recently downgraded its outlook for the third time in six months. Concerns about global growth predate the latest round of trade tensions.
While other events, such as a “no-deal” Brexit, also have an impact, it’s hard to ignore additional signs of softer growth that aren’t specific to geopolitics.
Prices for copper and other industrial metals declined significantly in the past month, giving back most of the year’s gains in a sign that demand is waning for many manufacturing and construction inputs. Oil is still well ahead of early 2019 lows, but it too has corrected from late April peaks.
At the same time, central banks around the world have been softening their language regarding the path for economic policy and interest rates. Futures markets have taken notice and are now pricing in potential rate cuts rather than rate increases by year-end. In their April 10 meeting, European Central Bank officials expressed concern about a return to stronger economic growth in the European Union in the second half of the year. Additionally, a string of weak economic reports has led ECB President Mario Draghi to comment on the central bank’s readiness to deploy all of its tools, should growth slow from here. Both the ECB and the U.S. Federal Reserve have paused the withdrawal of stimulative economic policy.
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For all the recent market volatility and ongoing concern, investors may be surprised to learn that the S&P 500 is still up double digits for the year. Foreign stocks have fared almost as well with the exception of emerging markets, though even the emerging market index was still positive for the year.
With strong year-to-date returns and growing uncertainty, it can be tempting for investors to try to time an exit from stocks. Current concerns also coincide with misguided investment wisdom to “sell in May.” While it’s never too late to revisit allocations, for a variety of reasons, it is not time to abandon stocks.
For starters, recall that the S&P 500—or any stock index, really—is a forward-looking measure of expectations. By the time everyone knows a piece of bad news, the expected impact has long been priced into the stock market. As an example, weak earnings growth in the first few months of 2019 was largely priced in by a big decline in stocks in the fourth quarter of 2018. As the calendar turned and investors looked beyond the first few quarters of the year, stocks began to rebound.
Consider also the impossibility of timing the markets. It has been a long time since we’ve seen a bear market for the S&P 500. Yet, the average investor should expect to see more than a dozen such 20% sell-offs in their investment lifetime. Investors would be better off avoiding bear markets, but that means accurately calling market tops and market bottoms to know when to get in and out. Missing by even a few weeks could mean a massive difference in performance.
Historically, 48% of the S&P’s best days occurred during a bear market, and another 28% took place in the first two months after a bear market. More than three-fourths of the stock market’s best days occur long before the average investor feels confident enough to get back into the market.
Market declines are inevitable, and we try to build our portfolio to weather such disturbances, but that doesn’t mean we do nothing as the storm approaches.
A down month is a great time to revisit asset allocation. It’s easy to be comfortable with a portfolio when everything is up, but a down market can inform us just how prone to regret we are as investors. If a short-term decline sows seeds of regret, it may be a sign that we are taking more risk than we should.
There is also a risk in benchmarking expectations against a high-water mark, such as statement values at the end of April. While most investment portfolios were worth more at the beginning of May than at the end, it is possible that stocks had become a little overvalued. Daily account values—or even a single month-end statement—don’t give a complete picture of worth.
Finally, a period of slowing economic growth also places a greater emphasis on the need for quality portfolio construction, though quality means something different, depending on the investment category:
- Within bonds—traditionally the safer part of a portfolio, it means focusing on companies that have not overextended themselves by gorging on cheap credit. That has been a concern for much of the last two years.
- Within stocks, it means focusing on quality earnings. In other words, investing in companies whose earnings are driven by innovation and market leadership rather than by mere participation in the rising tide of a broadly growing economy.
The transition to a slower-growth environment will likely continue to be accompanied by increased volatility. While we continue to find ways to keep risk in check, May’s performance reminds us of the range of outcomes for investors. An appropriate balance helps to navigate the risk, but it won’t strip it away.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
(initially posted May 31, 2019)
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