The stock markets in the US and the world continue to be very rewarding for most investors.
If you are broadly diversified, you should be benefiting from solids gains over the past years.
We see the economy as continuing to be strong and the majority of companies continue to report good revenue and earnings growth. Companies which are not growing or are being impacted by innovation and strong competition (many retailers, grocery store chains and energy companies, for example) have seen stock market returns far below the general market averages.
Stock market returns are correlated to current and future earnings expectations of companies. Over time, greater earnings result in higher stock prices. For evidence of this, take a look at GE and IBM over the past decade and Under Armour, which declined over 20% in one day this week after reduced sales expectations.
In the short term, stock market returns can be impacted by politics, but long term returns are not driven by politics. Our best advice is to ignore day to day politics and focus on the long term growth of the great companies of the world.
One of our core principles, grounded in academic financial research, are the following relationships: small stocks outperform large stocks, value stocks outperform growth stocks, International stocks outperform US stocks and Emerging Market stocks outperform US and International stocks. While our recommended portfolios have exposure to many asset classes, we recommend exposure to small, value, International and Emerging Market stocks, as they have greater long-term returns.
While these relationships do not hold true every year, we believe they are valid and will be rewarding for disciplined investors who are patient over the long term.
While valuations of certain individual stocks and some US indices seem quite high, the returns of some major indices have been driven by the performance of a small number of companies. The Dow Jones Industrial Average (DJIA) is comprised of 30 stocks. The WSJ reported yesterday that Boeing alone accounts for most of the DJIA’s gains for this year. For October, 3M, Apple, UnitedHealth, Caterpillar and McDonald’s accounted for over half of the DJIA’s gains. Our globally diversified stock portfolios consist of thousands of stocks, so your returns are broad based and not due to just a handful of companies. This should be reassuring to you.
As markets have risen, many commentators have stated that valuations are excessive and others ask if it is time to get out of the market. Valuations are much more reasonable for the asset classes we focus on, particularly considering that global interest rates are still historically low. The asset classes we recommend greater exposure to, such as small value companies, International and Emerging Markets, are cheaper than many major US stock indices (such as DJIA, S & P 500 and NASDAQ) based on various valuation metrics. Thus, given that these asset classes have provided solid returns and are still cheaper than many US stock indices, we are confident in our portfolio positions.
This does not mean that a market decline or correction cannot occur in the near term. On the contrary, markets are long overdue for a 10% or greater decline, on their longer term path higher. However, we would not recommend changing your stock allocation today just because of the gains of the past years. Those who have not been invested in the stock market, who are concerned or have been waiting for a pullback for the last year or two, are far behind those who have stayed the course and remained invested according to their written investment plan.
Our investment strategy of monitoring your portfolio to maintain your appropriate allocation to stocks provides you the benefit of discipline and the reward of “selling high.” We are disciplined about rebalancing throughout the year, not just at year end. We do not sell an entire asset class, such as completely getting out of emerging markets because it has outperformed this year. We may take some profits, but still leave exposure to each asset class.
We are positive about the announcement of the new Federal Reserve Chairman, Jerome Powell. His appointment requires confirmation by the Senate. He is expected to continue along the same path as Chair Janet Yellen, who has managed the transition of the Fed well during her 4 year term, which ends February 5, 2018. The US stock market had strong gains during her 4 years as Fed Chair. We expect Powell to lead in the same manner in the future, with gradually rising interest rates over the next few years, with some commentators suggesting he may be less restrictive from a regulatory standpoint.
The world is constantly changing. No one can predict the future. We could not have predicted the success of Apple, Amazon or Facebook’s stocks 10-15 years ago. But we also don’t know how these stocks will perform over the next 10-15 years. Past performance does not guarantee future returns.
Similarly, we could not have predicted 10 years ago that Bed Bath & Beyond would be worth much less today, Merck would be worth about the same and Exxon Mobil would be worth less than it was in 2007. These are just a few examples of why we believe in the broad diversification of using asset class mutual funds, which have dramatically increased in value over the past 10 years.
This week’s takeaway:
The asset class funds which we recommend are very broadly diversified and hold thousands of stocks. Their returns have been solid and not concentrated in a few stocks. There are some major indices whose increases are due to a small number of stocks. Also, the valuations of the asset classes which we overweight are more reasonably valued today than major US indices. This should be reassuring for our clients.