Equity and bond returns were bountiful in the first half, buoyed by rising corporate profits, increased dividends, falling interest rates, and low inflation. This was a nice reward for patience following the 2018 market swoon.
Time in the Market, not Market Timing
While not surprised by progress, we did not anticipate the magnitude. It’s a reminder of why we do not attempt “market timing.” Bartlett invests on the premise that stock prices ultimately parallel business results, rewarding a long-term investor by rising with higher corporate profits and dividends achieved by successful companies. But we’re mindful that investment returns occur in a less predictable fashion, happening in spurts. Consider that the S&P 500 Index returned 8.7% annualized over the last fifteen years, roughly matching the trajectory of corporate profits and dividends. But the pattern was irregular. Two of the fifteen years saw negative returns (2008 and 2018); two other years had barely positive returns (2011 and 2015); and in three years stocks zoomed with returns exceeding 20% (2009, 2013 and 2017). Over time, progress more than compensated for occasional setbacks, resulting in a very satisfying long-term result. But woe to the “timer” who missed just a few good periods. Of course, less volatile securities – bonds, cash and alternative investments – provide vital ballast for balanced accounts, helping to steady results for investors of more moderate risk tolerance.
Low Interest Rates
Want to be humbled? Try forecasting interest rates. Sooner or later, you’ll be confounded. Sixty-nine economists were surveyed in January by The Wall Street Journal, and all sixty-nine incorrectly forecasted the 10-year U.S. Treasury bond yield. Meanwhile, in December the Federal Reserve Board was planning for 3 – 4 increases in its policy interest rate in 2019. Today, just eight months later, it is expected to lower the rate this summer.
These economists and Fed policymakers are no lightweights. Their expectation for higher rates seemed plausible based on U.S. economic fundamentals. But economies elsewhere have stalled, especially in Europe. Global interest rates have declined as a result, and are near historic lows in many countries, as documented on the next page.
U.S. interest rates are above-average when viewed in a global context, a landscape that includes negative (yes, negative) yields in Western Europe. This remarkable situation conjures up two observations. First, we do not select bonds based on interest rate forecasts. We think this is as dangerous for the bond investor as “timing” is for the stock investor. Instead, Bartlett believes a safer strategy is to be carefully diversified in quality bonds across a spectrum of maturities. This provides steadier performance over the long haul, through all manner of interest rate cycles. Second, low interest rates are an important support for stock valuations. Equity and bond investments compete for investor capital, and it’s reasonable to expect quality stocks, over time, should easily surpass the hurdle of a 2% current return from U.S. government bonds, albeit with greater volatility. In fact, many of the stocks featured in Bartlett portfolios provide dividend yields that exceed the government bond yield. Moreover, dividend income from the former increases over time while interest income from the latter is fixed.
The current economic growth cycle – almost 10 years in duration – is now the longest expansion in U.S. history. We don’t need complicated analysis to recognize the cycle is in a later stage which means risk is trending higher.
A historical perspective, rather than forecasting prowess, keeps us alert to managing risk.
- Based on history, a normal amount of stock market volatility means the next year could feature a few 5% setbacks and possibly a 10% correction. For those relying on portfolio distributions, withdrawal requirements over the next year should be provided by a combination of cash, interest and dividend income, and maturing short-term bonds. This is a key protection against any fallout from stock market volatility.
- History also tells us that “bear market” selloffs exceeding 20% usually occur during recessions or economic slowdowns. Major market downturns are dangerous if eventual distribution requirements require stock sales when prices are low. The best precaution is to have an appropriate level of lower-risk bond and alternative investments, a contingency that should protect from having to sell stocks at inopportune times.
- Even for those prioritizing long-term growth and not relying on portfolio distributions, a prudently diversified portfolio should now include lower-risk assets. Such a portfolio will hold up better in difficult times. Furthermore, it will allow the potential to rebalance (i.e. adding to stocks) when adversity results in lower prices, making selloffs periods of opportunity rather than peril.
With good safeguards in place, long-term investments can be maintained. This helps minimize the costly “behavioral penalty” of selling low during market setbacks, which are both inevitable and nearly impossible to time.
On July 1, we were thrilled to expand our presence throughout the Midwest when Lodestar Investment Counsel, founded in Chicago in 1998, was merged into Bartlett Wealth Management. This relationship is yet another step that our firm is taking to better serve our clients and grow as a leader in the industry.
We love our profession and know our work is made possible by the loyalty of our clients and friends. We are very grateful for your confidence. Bartlett is aiming for another year of high client retention (98% is our goal) while adding new business at a steady pace.
We hope you enjoy a fulfilling and happy summer!