After a blistering start to the year, US stocks, as measured by the Russell 3000, declined nearly 6.5% in May1. Global trade negotiations continue to be at the forefront of investors’ minds as tensions with China escalated over the month and the markets reacted to the threat of new tariffs on Mexican goods beginning in early June. Much of the gains to start the year were supported by optimism that a trade deal between the US and China would be reached. Trade dealings and their impact on corporate earnings and economic growth will remain a driver of equity volatility for the remainder of 2019.
Of the 88 days the US stock market was open through the end of May, it posted negative returns for 34 days and flat or positive returns for 54 days2. Put another way, the US stock market posted a return greater than or equal to zero about 60% of the time so far in 2019. This level of daily fluctuation is expected and important to understand to remain disciplined through periods of volatility. History has shown that the total return of stocks over a long period comes from just a handful of days3. Since investors are unlikely to be able to identify in advance which days will have strong returns and which will not, we believe the prudent course is to remain invested during periods of volatility rather than try to strategically time the markets.
Despite the equity decline in May, the Bloomberg Barclays U.S. Aggregate Bond Index gained 1.78% and is up 4.80% for the year. We believe the best hedge investors have against declines in stocks is high quality fixed income and that was the case in May. The average annual decline for down years in the US stock market is -12.45%. The average annual return for the Aggregate Bond Index during those years is 6.72%4.
Not only has the US bond market performed well considering recent equity volatility but having exposure to high quality global bonds has also been beneficial. The DFA World ex US Government Fixed Income portfolio returned over 2% in May and is up 6% for the year. Since yields across countries do not move in lock-step, investing globally can reduce volatility and provide meaningful diversification benefits5. Global recession fears, and how the US Federal Reserve and other central banks choose to act in response, will impact how the broad bond market performs during the remainder of the year.
While equity market volatility can be nerve-racking for investors, reacting emotionally and changing long-term investment strategies in response to short-term declines could prove more harmful than helpful. By having specific rebalancing thresholds that dictate when to make trades in your portfolio to bring it back in line with it’s target asset allocation, RWM looks to bring discipline to the investment process and avoid letting emotional reactions dictate buying and selling decisions. Although the markets may move in any direction over the short term, buying into what is below target using proceeds from what is above target is a disciplined approach that maintains a portfolio’s long term focus. We also look to utilize any cash flows into or out of a portfolio as an opportunity to rebalance. As we move closer to the second half of 2019, please let us know if you have any upcoming withdrawals or contributions we should be aware of.
References
1Source Morningstar, Inc.
2Source Yahoo Finance. US Stocks are represented by the Russell 3000 Index.
3 Source Dimensional Fund Advisors, “Here’s the Prescription” by David R. Jones. Had an investor missed the 25 single best days in the S&P 500 Index between 1990 and the end of 2017, their annualized return would have dropped from 9.81% to 4.53%.
4 Source Dimensional Fund Advisors, Dimensional Returns 2.0. Annual Returns reviewed from 1976-2018. US Stocks are represented by the S&P 500 Index. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
5 Source “Reviewing Raffa Wealth Management’s International Allocations to Equity and Fixed Income: A White Paper” produced November 21, 2012 by Mark Murphy, CFA.