The second quarter of 2019 ended about the same way it started, with positive returns across the financial markets. Let’s recap what happened, what we learned and where we go from here.
One Rough Month Doesn’t Make a Quarter - A rocky month of May was bookended by a strong April and June. The S&P 500 fell almost 6% in May, but bounced back strong with a 7% return in June. Combined with a positive April, this left the total return for the quarter at 4% and the year-to-date return at over 18%.
Where One Leads, Others Follow - The S&P 500 wasn’t the only index to post strong returns this quarter. The Russell 2000 index, which tracks small cap US stocks, was up about 2% and is up almost 17% for the year. The MSCI EAFE index, which tracks developed market international stocks, was also up about 4% on the quarter and is up about 14.5% on the year. Emerging Market stocks were up a little less than 1% and are up close to 11% on the year and REIT’s were up about 2% on the quarter and are up over 19% on the year.
Even Bonds Joined the Party - In a stark reversal from the rising rates we saw towards the end of last year, interest rates continued to trend lower in the 2nd quarter. Bond prices rise as rates drop, so bonds also enjoyed strong returns this quarter. The Barclays Aggregate Bond index posted a 3% return and is up 6% year-to-date.
What did we learn?
Trust the Process - Our investment process is built on the fundamental belief in keeping costs low, managing risk through appropriate asset allocation, diversifying broadly and rebalancing regularly. We don’t know what is going to happen in the markets from one month to the next so we don’t make investment decisions based on predictions. We follow a process and stick with it for the long-term. As Annie Duke puts it in her great book, Thinking in Bets, “What makes a decision great is not that it has a great outcome. A great decision is the result of a good process, and that process must include an attempt to accurately represent our own state of knowledge. That state of knowledge, in turn, is some variation of “I’m not sure.”
Diversification Benefits Are Harder to See in the Short-Term - Over the past 12 months we have seen examples of this on both the downside and the upside. Last fall we saw an extended period of time when both bonds and stocks were moving lower. So far this year we’ve seen the opposite as both bonds and stocks have done extremely well. Different asset classes will often go through periods of time where they will move in tandem, particularly in strong up or down markets. However, over the longer term we continue to see reduced volatility and lower drawdown risk in a well-diversified portfolio.
Predictions Are Impossible, Still - No matter how many times we remind ourselves that it’s impossible to predict the future, we still try to do it. It’s in our human nature and probably will never change, so the best we can do is to continue to remind you how fruitless it is. The Wall Street Journal recently had an article about interest rate predictions from the beginning of this year from a survey of economists. They included this excellent graphic, showing where we started the year, where they predicted we’d be now, and where they predicted we’d be at the end of the year. As you can see, nobody was even close to guessing rates would drop as far as they have this year:
Where do we go from here?
Joachim Klement wrote a great article on the CFA Institute’s website recently, where he relayed a story about a conversation with a taxi driver. He and his wife were driving in London on a beautiful, sunny summer day, and the driver told him “Today is one of the most dangerous days to drive.” He goes on to point out that “on a sunny day with little traffic, we tend to let our guard down and are more easily distracted.” Meanwhile, when weather conditions are bad or we are stuck in traffic we tend to be more alert and more cautious.
I’m not so sure the taxi driver is correct, as most research seems to indicate accidents are much more likely in bad weather conditions. But his comment, and Joachim’s article, show us that we are much more aware of the risks we face when conditions are bad. If we are driving in the rain and snow we are much more alert than we are when the sun is shining. But that doesn’t mean the risks go away with the rain. The same can likely be said of your investment portfolio, as the risks are highlighted when times are bad and muted when times are good.
Right now the sun is shining on the markets. Virtually every asset class has positive returns for the year, with many up double digits. But it wasn’t that long ago we were driving through a rainstorm, as the market fell double digits in the 4th quarter of last year. You likely feel much more comfortable now, but don’t get complacent. Stick to the process, review your financial plan and rebalance the portfolio if necessary. Doing so will make the next rainstorm a little easier to drive through.
-Chris Benson, CPA, PFS
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.