Midyear 2018 Investment Outlook
Brian Kilb: Kyle, here we are halfway through the year. When you look back on the second quarter in the context of the first half of the year, we were out of the gates in January, gangbusters for stocks. Gave a little bit of that back in February, but mostly kind of treaded water since then. Volatility’s been a big word this year. Such a quiet period for so long, but in January and February, things got a little rocky. But since then, it’s been a little up, a little down, a little good, a little bad. What are your thoughts?
Kyle Tetting: You know, I think investors seeing second quarter returns might be a little bit surprised. We talk about that volatility, and the fact that it returned for a little while. It’s now back to what we’ve always thought were more normal levels, not the elevated levels that I think it feels like for so many investors. But if you just look at the return piece, it was a really great quarter. You put four of those quarters that we just had together, and you’re talking about what’s certainly an above-average year. And so, I think investors just need to remember that we’ve gotten some pretty strong returns recently.
Brian: We have a tendency to focus on stocks a lot, but the bond market may be a more interesting story so far this year. Interest rates spiked pretty good early in the year. Again, much like the market, settled since, but it’s been a pretty rugged fist six months for bonds. And I think a lot of people might not expect that there’s times in your portfolio where you may even go backwards a little bit in your bond portfolio.
But a reminder to all that they’re there for safety. And if, in a short period of time, you’re even underwater a little bit, don’t let that get you too nervous.
Kyle: Yeah, and in theory, the stock portion of the portfolio should be the piece that’s carrying you in a time like this. For the most part, it has. And so, it doesn’t feel as bad to give a little bit back in bonds, other than that sense that bonds are supposed to be the safe piece. But you’ve got to remember we’re coming off an environment where bond yields have been historically low. Finally starting to see some interest in those safer investments now. So, you have investors not needing to reach as far for yield anymore. You don’t have to take unnecessary risk in your fixed income and your bonds.
Brian: You’re not getting paid enough to take the additional risk of longer maturities, or the potential that corporate America quality deteriorates a little bit. And I just want to remind people be careful about taking a little bit of extra risk in bonds to make a little bit of additional money, when it could end badly if credit quality deteriorates.
Kyle: The reality is that right now, while there aren’t any signs that a recession is imminent, that business conditions are going to deteriorate, you know, the market has priced that in. And so, you’re not getting paid to take risk in bonds. You’re not getting paid to take a lot of risk in other places. And maybe that means that right now we need to reevaluate the way that we’re building portfolios a little bit.
Brian: Let me just remind people that the news we got in the second quarter about corporate earnings was just fantastic. You know, corporate earnings – after nine years of recovery and expansion, up 26% in the first quarter. If anybody wants to wonder why the market’s held up or why it’s done as well as it has in recent memory, it’s because earnings have been strong.
Kyle: And I think there is some nuance to that earnings piece. You know, a good bit of the earnings growth has come from the growth side of the market. That when the economy’s going really strong, growth tends to be the piece that holds things up. But we’ve now seen some divergence in terms of valuation there.
We’ve leaned into growth for so long now because it’s been such a great opportunity, but growth does have a tendency to react pretty violently when the recession finally comes, when economic growth finally slows down. And so, you know, if you can get those value stocks a little bit cheaper than you’ve been able to get them relative to growth in the past, I think that says a lot about maybe where you start to move some of your positioning going forward.
Brian: You know, that’s a great point, and I think on top of that, you think about, well, if we’re in the latter stages of this cycle domestically, where are the opportunities? And I like a lot of what’s going on overseas. Now, admittedly in the short term, the strength of the dollar has hurt some of those overseas investments, but there’s still a strong argument that over the long run, there are great opportunities overseas. So that’s something to think about as we reallocate our portfolios as well.
Kyle: And there are political risks there, and there are certainly some risks that maybe have hung over from what was really two European recessions and from what’s been decades now of slow growth in Japan and, you know, risks in the emerging world. But those risks are always going to be there, and you just need to make sure that you’re being compensated to take those risks.
So, for investors really looking at where the opportunity is, I think it’s going to be a more global investment portfolio focused on the best companies, not simply focused on those companies that are here in the U.S.
Brian: So it kind of goes back to the beginning of, well there’s a number of good things going on, certainly a few things to worry about. Trading in a bit of a range through the second quarter. Wouldn’t be surprised if we continue a pace that way for the next few months. Let’s see what happens.
Handling a record shift in stock volatility, a Money Talk Video with Dave Sandstrom
Be patient holding bonds as rates rise, a Money Talk Video with Steve Giles
Investing away from home, by Kyle Tetting
(initially posted July 13, 2018)
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