Trade War Stokes Uncertainty: Q2 2018 Market Update

At SigFig, our advice remains consistent quarter after quarter: A globally diversified portfolio across multiple asset classes helps balance risk and return for long-term investors. As we explore some of the noteworthy second-quarter developments in global economies and markets, remember that, if you have appropriately diversified your investments for a long-term horizon, it is usually better to remain invested—even when markets look volatile in the near term.

Keeping a close eye on the trade war

Investors and businesses continue to monitor the trade war closely. As protectionist rhetoric escalates, the focus remains on the dynamic between the U.S., China, and the European Union (E.U.), the world’s three largest economies. During the second quarter, the U.S. announced a 25% tariff on $50 billion of Chinese goods, about 10% of the U.S.’s Chinese import volume. Several days later, after the Chinese government indicated it would respond in kind with similar tariffs, the White House said it was prepared to impose tariffs on an additional $200 billion worth of Chinese imports.

Other countries are also involved. In late May, the U.S. moved ahead with tariffs on aluminum and steel imports from the E.U., Canada and Mexico, after a two-month exemption. The E.U. imposed tariffs against more than $3 billion in American imports as retaliation; Canada and Mexico have also enacted tit-for-tat duties against the U.S.

Investors reacted to rising trade tensions with concern that worldwide economic growth could be impacted, as volatility in global stocks increased.

While the current economic impact of announced tariffs appears minimal, the uncertainty of escalation poses a risk to business confidence and capital spending plans. A greater concern is that the trade war spirals out of control to become a significant macroeconomic disruption, with wide but poorly understood impact. Consider, for example, analysis from Nobel laureate economist Paul Krugman, which suggests an all-out trade war could lead to a 70% reduction in trade. Additionally, the International Monetary Fund (IMF) recently pointed to a trade war as the greatest near-term threat to global growth and said rising tensions could cost the global economy $430 billion. Such an escalation could lead to more market volatility—another reason to diversify and take a long-term view.

Continued strength in the U.S. economy

U.S. stocks advanced in the second quarter as economic fundamentals remained largely intact and many indicators suggest a healthy economy. Unemployment ticked up slightly to reach 4.0% in June and job creation maintained a strong pace. Inflation is a bit above 2%, very near the level the Federal Reserve (Fed) targets for its price stability and employment objectives. The revised reading of first quarter gross domestic product (GDP) clocked in at 2.0%, and the second quarter is expected to register even stronger growth, with the Federal Reserve Bank of Atlanta GDPNow model projecting a rate of 4.5%, though the economy is unlikely to sustain growth of this magnitude. Consumer confidence decreased in June, reflecting a modest reduction in optimism.

Companies revealed first-quarter earnings growth rates that remained near all-time highs. The S&P 500 reported earnings growth of 25%—the highest growth since the third quarter of 2010. Wages, on the other hand, are growing but not as quickly as earnings: Average hourly earnings have risen just 2.7% over the last year. Tax reform remained a tailwind for corporations as the benefits of lower tax bills and repatriation of cash from overseas are still unfolding. In all, U.S. stocks advanced, with the Vanguard Total Stock Market ETF (VTI) gaining 3.9% during the quarter.

As the economy looked strong by most measures, the Fed raised its benchmark interest rate during its June meeting, as widely expected. The Federal Open Market Committee voted to lift the target range for the federal funds rate by 25 basis points (a quarter of one percent) to between 1.75% and 2%. The committee’s “dot plot,” which illustrates members’ expectations for future rates, showed two more hikes are anticipated for this year.

Developed international economies muddling through

Overseas, stocks in developed international markets generally declined in the second quarter, with the Vanguard FTSE Developed Markets ETF (VEA) falling 1.9%.

The U.K. faces continued uncertainty surrounding its Brexit negotiations with the E.U., which impaired corporate and consumer confidence. Several major corporations are exploring options to locate headquarters on the European continent, rather than London, in a clear expression of this concern. Elsewhere in Europe, Italy’s new anti-establishment government stoked fears of an exit from the E.U., sending Italian bond yields soaring. Economic growth in the eurozone slowed in the first quarter, as a June report showed GDP expanded by 0.4%, the softest pace since mid-2016.

In Japan, the economy shrank at an annualized rate of 0.6% during the first quarter. The contraction marks the end of a two-year growth run in Japan as declines in investment and consumption plus weaker export growth weighed on the economy.

Emerging markets face headwinds

Emerging markets stocks faced stiff headwinds in the second quarter, as the Vanguard FTSE Emerging Markets ETF (VWO) declined 9.7%. The deteriorating global trade backdrop was a concern, along with a strengthening U.S. dollar. The WSJ Dollar Index, which measures the dollar against a basket of 16 other currencies, rose 5.1% in the second quarter, its first quarterly gain since 2016. A stronger U.S. dollar can hurt emerging markets by pushing down the value of their local currencies, making dollar-priced goods more expensive to buy and stoking inflation. At the same time, it’s worth noting that many emerging market countries prefer a stronger dollar, as it likely supports their exports to the U.S. That said, several emerging market countries worked to bolster their currencies in the second quarter by stopping rate cuts or even tightening monetary policy. The central banks of Turkey and Argentina, which were also confronting exceptional political and economic issues, were forced to take particularly dramatic action.

In China, the situation is complex, as trade war worries and increasingly problematic economic challenges—namely its sizeable debt problems—contribute to lackluster stock market performance. Markets in Brazil—Latin America’s largest economy—also lagged as a major trucker’s strike over increasing fuel prices paralyzed commerce.

Global interest rates diverge

Around the globe, monetary policies of major central banks continue to diverge as the days of synchronized “loose money” central bank policies fade into the rearview mirror. As noted above, the Fed maintained a tightening stance, while the Bank of England held steady. Meanwhile, the European Central Bank outlined plans to end its massive stimulus program by the end of 2018 and indicated that a rate hike is unlikely to come before the summer of 2019, depending on data. In Japan, the central bank maintained its ultra-loose monetary policy, especially important as their economy contracted last quarter.

A complex global economy demands a strategic, globally diversified portfolio

A core characteristic of the global economy is that it is too complex to move in a coordinated fashion. Some economies, like the U.S., are growing rapidly, with an appreciating stock market. Meanwhile, other developed nations struggle to maintain the same pace. Self-inflicted trade war talk contributes to widespread uncertainty, though major trade war affected economies appear to be shrugging off any drag caused by the tariff tensions.

As noted in our previous update, SigFig made mild adjustments in our portfolio allocations, reducing longer-term fixed income investments—which are more sensitive to a rising interest rate environment—toward shorter duration bonds and equities. On the whole, we remain reasonably bullish about the global economy and believe the prospects for long-term investors are positive.

Finally, it is important to remember that market performance and economic indicators do not always move hand-in-hand, so we maintain our view that clients invest in a strategic, globally diversified portfolio that is aligned with their preferred risk tolerance and time horizon.

If you have questions about what the right asset allocation is for you based on your goals, take our risk questionnaire or talk to one of our financial advisors.


Aaron Gubin

Aaron Gubin leads research for SigFig’s Wealth Management team. He holds a Ph.D. in Finance and taught investments and portfolio management to graduate and undergraduate students before coming to SigFig. His research focuses on asset allocation, behavioral finance, and investment management.

Quarterly Market Update: 2017 Review and Outlook for 2018

Executive Summary

Diversification is a common theme at SigFig, and with good reason. A portfolio that is globally diversified across multiple asset classes helps balance risk and return for long-term investors. That’s why SigFig diversifies its managed portfolios across thousands of companies in nearly 50 countries, ensuring a balanced mix of equities (stocks), corporate and government fixed income (bonds), and real estate.

Our advice remains consistent for the coming year: Investors should diversify their portfolios with many investment vehicles across many countries and markets. In continued support of this strategy, we are adjusting our recommended allocations, which you will see reflected in your updated portfolio.

Our 2017 review and 2018 outlook covers several points that informed these updates:

  1. The continued strengthening of the US economy
  2. A calmer U.S. legislative agenda going into the midterm elections, following tax and healthcare reform bills
  3. The continued growth of a still-uncertain global economy
  4. Rising interest rates and the slow but steady unwinding of quantitative easing by major central banks
  5. Lower expectations for long-term returns than in prior eras, as investors work to update their long-run investment strategies

A year ago, in the wake of the 2016 presidential election, we noted that although the U.S. stock market outperformed a globally diversified portfolio during the final months of 2016, long-term investors should continue to focus on a broad, multi-asset class approach. In 2017, globally diversified investors were rewarded: Though U.S. stocks had an excellent year, international markets did even better.

We remain cautiously optimistic that near-term prospects for diversified investors are positive, though long-term investment performance is expected to be lower than we’ve seen in the past 12 months.


Strong growth continues for U.S. economy 

The U.S. economy is healthy; most statistical and qualitative measures indicate a full recovery from the Great Recession of 2008-2009, and economic data for 2018 remains encouraging:

However, it is important to distinguish between economic performance and stock market performance: A strong economy does not necessarily equate to an up market, or vice versa. It is empirically difficult to predict how markets will perform in the future. That said, the current macroeconomic climate is promising for continued market growth.

U.S. stocks had an excellent 2017. The S&P 500, a large-company index, rose 18% last year to reach record highs. It’s also worth noting that U.S. equity markets were reasonably stable — consistently marching upwards throughout the year, with few hiccups.


(Chart illustrates the 2017 price performance of VTI, an ETF tracking U.S. stocks; source: Google Finance)

Domestic politics have not distracted the market…yet

In previous updates, we noted that although Washington’s focus was on healthcare, investors should stay focused on the Republican tax reform agenda. This proved to be a sound strategy, as the primary repeal of the Affordable Care Act faltered. Republicans ultimately shifted their attention to tax reform, resulting in two key changes that affect investors.

One was a reduction in lower corporate taxes, easing the way for business expansion. The other established rules requiring companies to pay tax on overseas earnings, though they can then bring that cash back to the U.S. without paying additional tax.

Moody’s estimated that U.S. companies have amassed $1.9 trillion in overseas holdings, which is likely to come back to U.S. shareholders. Though companies may initially report losses from this near-term tax bill, we expect U.S. investors to benefit over the coming years as companies redistribute capital in the form of higher dividends and share repurchases and reinvest in their businesses.

As Congressional campaigning for this year’s election cycle gets underway, we don’t anticipate any major challenges. The debt ceiling debate will return in March, but we anticipate that Republicans will negotiate an extension of credit through at least the November election. With legislative stability in Washington and tax reform in the rearview mirror, the coast is clear for the U.S. stock market to continue its bull run — at least until election season gets into full swing.

Developed market economies strengthen and emerging markets bound forward

A similar story is echoing across a number of international markets: As economies in Europe and Japan continue to recover from the 2008-2009 global recession, stock market growth is accelerating.

Though unemployment in the Eurozone is notably higher than in the U.S., it continues to tick down. Germany, the European Union’s largest economy, has seen its unemployment rate fall to just 3.6%. Though most of the economic news from Europe is positive, the effect of British withdrawal from the E.U. remains a point of uncertainty, which will likely to drag on medium- and long-term growth.

Stocks in developed markets outpaced those in the U.S. with an excellent year, up 23%. Similarly, international developed markets enjoyed relatively low volatility throughout the year, marching consistently upwards.


(Chart illustrates the 2017 price performance of VTI (in blue) an ETF tracking U.S. stocks; VEA (in red), an ETF tracking Developed International Market stocks; and VWO (in orange), an ETF tracking Emerging Market stocks; source: Google Finance)

By far, the best performer among the asset classes in our recommended allocations were emerging market equities. They jumped ahead of developed countries’ stocks, soaring to 30% returns in 2017. Economic growth and low inflation in developed nations spurred an appetite for imports from emerging markets and fueled growth in emerging economies, leading to top-tier performance for emerging market stocks.

Though international economies are growing and stock markets appear poised to continue their strong performance, uncertainty should remain a core concern for any investor. Tensions on the Korean Peninsula, issues with Russia, and management of China’s slowing economic growth are but a few issues that could spark change in our positive outlook. Despite these uncertainties, we continue to recommend a globally diversified equity portfolio.

Global interest rates are on the rise

Positive performance in 2017 was not limited to equities. Though central banks in developed markets began raising interest rates, fixed income still provided modest returns for investors.

As U.S. and international economies grow, central banks around the world are raising interest rates to moderate this growth. The U.S. Federal Reserve began its rate-hike process in late 2015 and continues to slowly increase its benchmark borrowing rates in an effort to mitigate any chance of economic overheating. The European Central Bank began raising rates later than the U.S., but globally rising rates are contributing to a long-term expectation that bond values will fall.


(Chart illustrates the 2017 price performance of AGG (in blue), an ETF tracking Investment Grade U.S. Fixed Income; TIP (in red), an ETF tracking Treasury Inflation-Protected Bonds; and EMB (in orange), an ETF tracking Emerging Market Fixed Income; source: Google Finance)

Emerging market bonds, a source of extra yield for fixed income investors, provided better returns than U.S. investment grade bonds through 2017. As global interest rates inch up, however, the search for yield will become easier, likely reducing the demand for bonds from emerging market countries.

SigFig model portfolio adjustments

In light of the changing interest rate environment, SigFig’s portfolio allocations are shifting away from longer-duration and international fixed income positions, which are more sensitive to interest rate changes, towards shorter-duration bonds.

We continue to value high-quality investment-grade fixed income for diversification and volatility balance in all of our managed portfolios. The resulting change in our allocations reduces exposure to longer-duration Treasury Inflation-Protected Securities (TIPS) and emerging market bonds while increasing exposure to U.S. Investment Grade Bonds and Short-Term Treasuries.

Meanwhile, the mix of stocks and bonds will remain consistent with our historical view that investing in a wide range of asset classes provides a balanced approach to risk and returns.

We remain optimistic about the global economy in 2018 and believe the prospects for long-term investors are positive. We continue to recommend that our clients invest in a strategic, globally diversified portfolio that is aligned with their preferred risk tolerance and time horizon.

If you have questions about what the right asset allocation is for you based on your goals, take our risk questionnaire or talk to one of our financial advisors.

Aaron Gubin

Aaron Gubin leads research for SigFig’s Wealth Management team. He holds a Ph.D. in Finance and taught investments and portfolio management to graduate and undergraduate students before coming to SigFig. His research focuses on asset allocation, behavioral finance, and investment management.

Q3 2017 Quarterly Market Update: The Fed shows faith in the U.S. economy

In September, the Federal Reserve announced that it would begin selling off its enormous $4.5 trillion portfolio of bonds. This is the clearest sign yet that the bank believes the U.S. economy is well on the path to recovery.

The Fed first began purchasing the bonds in 2009, to ease the effects of the Great Recession. Known as Quantitative Easing (QE), the bond-purchasing program served two purposes: to inject cash into the financial system and drive down interest rates. This, in turn, put money in consumer’s pockets, kick-starting and stimulating greater economic activity.

Buying government securities to manage short-term interest rates is a common strategy used by the Fed. The enormous scale of the bond purchase, however, was unprecedented.

How bonds spurred the economy back into action

It’s easiest to think of a bond as an IOU. It’s a loan that contractually defines the principal amount being borrowed, the interest rate, and the date by which it will be repaid. Because the interest payments — also called “coupons” — don’t change once they’re set by the contract, bonds are commonly referred to as “fixed income.” Their unchanging nature makes them easy to trade in the market — the buyer and the seller just need to agree on a price.

Pricing is often a function of demand. With bonds, it’s specifically driven by the demand for higher returns. A bond’s return depends on how much interest it generates (coupon interest) and how much the net gain will be when it’s repaid (capital gains).

When interest rates increase, as they have lately, fixed income investors prefer to buy newer bonds with higher coupons and sell their older bonds with coupons that reflect the earlier, lower interest rates. Demand isn’t as high for the older bonds with smaller coupons, so their prices drop accordingly. The reverse happens when interest rates fall: the older bonds have larger coupons, so they’re worth more. As a result, prices go up.

In these scenarios, interest rate movement causes price adjustments, but it’s also possible for bond demand to push rates.

When the Fed purchased $4.5 trillion of bonds, its sheer purchasing power caused bond prices — and thus, capital gains — to rise, thereby increasing returns for bondholders. New bonds could then be issued with lower coupons, because borrowers didn’t need to offer a high interest rate to attract buyers. This action drove down interest rates across the economy.

The lower interest rates also meant that companies could cheaply borrow from investors and banks to expand their businesses and hire more workers. This was a shot in the arm for the economy, helping boost inflation from dangerously low levels.

Now that the economy is back on track, the Fed is reversing course, slowly raising interest rates and beginning to unwind its massive balance sheet. Some fixed income investors lament this reversal because their bonds could lose value due to falling rates and the Fed’s bond-selling pressure. In a broader sense, though, it is an encouraging sign of economic health that the Fed has begun this process.

Easing the Fed’s foot off the gas

With more money in consumers’ pockets, the economic engine is primed for continued growth with less direct assistance from the Federal Reserve. Already, the U.S. economy appears quite strong and stable: the second quarter saw a 3.0% increase in gross domestic product (GDP)  — the thirteenth consecutive quarter of growth.

Moreover, after a long period of stagnant wages, evidence suggests that an increase in income growth is on the horizon. Unemployment has hovered between 4.2% and 4.4% since May 2017, pressuring employers to increase wages as they struggle to recruit and retain workers in a tight labor market. In fact, Target Corporation recently announced a three-year plan to increase minimum retail employee wages to $15.

image 1

(Chart illustrates the year-to-date price performance of VTI, an ETF tracking the total US stock market, as of September 29, 2017; source: Google Finance)

Meanwhile, despite the occasional blip, U.S. equities continue to soar, up nearly 14% for the year. Inflation and interest rates continue to remain low, guided by the gentle nudges of the Fed’s monetary policy.

We still expect the Republican-controlled Congress to push a tax plan that benefits shareholders by reducing capital gains taxes. A tax amnesty bill allowing companies with offshore cash could also enhance stock market returns.

These economic signals suggest continued growth in the broader U.S. economy and stock market, but with a couple of caveats. First, it is nearly impossible to time markets successfully. Second, North Korea uncertainty drags on investor sentiment. Though we anticipate continued growth in US equities, a globally diversified investment strategy continues to be the right call for most investors.

Global equities outperform the U.S.

As well as the U.S. stock market has performed, international developed markets have outperformed, up nearly 18% for the year. Global stability and improving economic conditions in Europe and Japan have contributed significantly to the upswing. European unemployment continues to fall, down to 7.7%. And the re-election of Angela Merkel suggests the strong German economy will continue to lead the European Union through its tough negotiation with the United Kingdom over Brexit.

image 2

(Chart illustrates the year-to-date price performance of VEA, an ETF tracking developed market equities, as of September 29, 2017; source: Google Finance)

Emerging markets continue to be a top performing asset class this year, up more than 20% for the year.

image 3

(Chart illustrates the year-to-date price performance of VWO, an ETF tracking emerging market equities, as of September 29, 2017; source: Google Finance)

Stay the course

The U.S. stock market is enjoying a fine year, and international stocks are recovering from recent lagging performance to help boost returns. Though U.S. fixed income may soften as the Federal Reserve sells off its bond portfolio and ticks up interest rates, the takeaway is that the U.S. economy is performing well. A stronger economy means good things for bond holders, even if returns weaken.

We continue to recommend that our clients invest in a strategic, globally diversified portfolio aligned to their preferred risk tolerance and time horizon. If you have questions about what the right asset allocation is for you based on your goals, take our risk questionnaire or talk to one of our financial advisors.

Aaron Gubin

Aaron Gubin leads research for SigFig’s Wealth Management team. He holds a Ph.D. in Finance and taught investments and portfolio management to graduate and undergraduate students before coming to SigFig. His research focuses on asset allocation, behavioral finance, and investment management.

Q2 Quarterly Review: Making Heads or Tails of Ongoing Market Growth

Over the past quarter, the US economy has continued its slow but steady growth trajectory. The stock market is up 8% for the year to date, and we continue to see signs of confidence in the economy’s direction.

In our Q2 review we explain why you shouldn’t confuse stability with predictability or try to time the market, and why our view of the US economy and markets remains consistent for now.

Suppose we flip a quarter three times and each time, it comes up heads. What does that tell us about the next flip?

Some might draw the conclusion that the coin is rigged in some way, and the next flip will also be heads. Others fall prey to the gambler’s fallacy and bet on the opposite, believing tails are “due.”

But the fact is, we can’t know what the coin will do after just three flips. A perfectly fair coin lands heads three times in a row about once in 8 sets of tosses. So if the coin is rigged, three flips is too small of a sample size to tell. As a result, our best guess should remain at 50% heads.

It’s not all that different from what’s going on in the current market environment: the US has been experiencing a long stock market boom, and many international markets are doing quite well—but does that mean we know what will happen next? Have we seen enough data to change our current investment strategies?

The short answer is, probably not. Let’s take a closer look at why, as we work to separate the signal from the noise.


Chugging right along

We previously noted that, though its growth has been modest, the US economy has been steadily improving, with gross domestic product (GDP) up 1.4% in the first quarter. Unemployment reached a 10-year low in May, and all major U.S. banks successfully completed stress testing, alleviating concerns that the financial sector is undercapitalized. Then, in June, the Federal Reserve Bank nudged its benchmark interest rate a quarter point higher, to 1.25%, further signaling confidence in a strengthened economy. There are plenty of signs that consumers, too, are feeling good about the economy: restaurants are full of patrons, and airports and roads are full of travelers.



(Chart illustrates the year-to-date price performance of VTI, an ETF tracking the total US stock market, as of July 10, 2017; source: Google Finance)

In Q2, the US stock market continued to rise, up almost 8% for the year to date. Even better for investors, the market has enjoyed 258% gains in the S&P 500 since March of 2009.  So, how much longer can we expect this good fortune to continue?

Although the current bull run has been long, it’s not recordbreaking in length or return. Since 1926, US investors have enjoyed 11 bull markets (periods that follow declines of 20% or more). The current market boom still trails the 1990s dot-com bubble in both length (113 months) and total return (417%).

Right now, inflation and interest rates remain low, despite the fact that we are near full employment. Through gentle nudges, the Fed can tighten monetary policy to raise interest rates while still encouraging economic growth.

As a result, short-term interest rates have crept up, yet long-term rates have not moved appreciably. That means bond prices haven’t fallen for long-run fixed income investors, either. The yield curve is flattening and we are watching that closely. Continued low unemployment should drive wage increases, and combined with a growing economy, this should move inflation toward the central bank’s long-run target.

We also still expect the Republican-controlled federal government to make an effort to reduce capital gains taxes. Tax cuts are important to their conference and could be positive for investors. A tax amnesty bill on repatriating corporate cash could follow tax reform.

Growth should continue, but the future is unpredictable. Given how little has changed over the last few months, our view of the US economy and markets remains consistent. It’s nearly impossible to time the market—and empirical evidence suggests it is better for investors to simply ride the waves than to try to enter at the bottom and exit at the top. A diversified investment strategy continues to be your best bet.


Abroad, a similar story

 Economic growth continues slowly and steadily in developed countries in a similar trajectory to the US. Developed market equity returns are up 12.6%  and are outpacing the US in the first half of the year. This upward trend is encouraging stability, especially in markets that are hungry for predictability.



(Chart illustrates the year-to-date price performance of VEA, an ETF tracking developed market equities, as of July 10, 2017; source: Google Finance.)

Following recent elections in France and Britain, major European markets are on the upswing. Since the Euro credit crisis, the Eurozone has grown steadily, now at a 1.9% growth rate. At the same time, unemployment, which hit a high of 12.1% in major European economies, has fallen to 9.1%.

And while over the last twenty years, the Japanese economy struggled to gain traction, growing its GDP just 0.7% per year, now their GDP growth rate has almost tripled the long-run average at 2.2%, while the Japanese market benchmark, the Nikkei, is close to three-year highs.

These signs and others point to consistent growth and improved returns for developed markets. Furthermore, because developed markets have trailed the US stock market in bouncing back from the global recessions in 2008, international equities may have significantly more room to advance.


(Chart illustrates the year-to-date price performance of VWO, an ETF tracking emerging market equities, as of July 10, 2017; souce: Google FInance.)

Emerging stock markets have been the top performing asset class this year, up 14%. This sort of global economic growth is encouraging, though commodity prices continue to lag. Down the line, this could weigh on emerging economies that rely on the export of raw materials. However, as developed economies continue to expand, their demand for raw materials and imports from emerging economies will grow as well.


So are we getting a clear picture?

For the last several years, and especially in the last few months, investors have enjoyed steady returns in their portfolios. US and international equity markets are seeing double-digit annual returns, and bond yields have held firm even as the Fed increases short-term rates.

Though the US’ eight-year bull market run feels like a long time, it is important to remember that it is still a relatively small sample. Plus, it is nearly impossible to accurately predict market behavior, and research shows that early exits from bull markets or late entries following bear markets create significantly worse long-run returns than a buy-and-hold strategy that rides the waves.


We continue to recommend a strategic, globally diversified portfolio that is aligned with your preferred risk tolerance and personal time horizon. If you have questions about what the right asset allocation is for you based on your goals, take our risk questionnaire or talk to one of our financial advisors.

Aaron Gubin

Aaron Gubin leads research for SigFig’s Wealth Management team. He holds a Ph.D. in Finance and taught investments and portfolio management to graduate and undergraduate students before coming to SigFig. His research focuses on asset allocation, behavioral finance, and investment management.

Q1 Quarterly Review: Enjoy the Ride, but Don’t Drop the Reins

What would you say drives your investment decisions: hard facts or gut feelings? The line between the two can feel blurry when your methodology isn’t well defined. Even when you swear you’d never let world affairs distract you from your strategy, natural human biases can sabotage your best efforts.

When it comes to portfolio analysis and investment decisions, we know we should emphasize facts and critical thinking. However, we tend to gravitate toward the data that supports our beliefs — this is called “confirmation bias.” Unfortunately, simply being aware of your biases isn’t enough to steer clear of their effects. You need controls in place that will help you sidestep subjectivity when emotion threatens to obscure logic.


Seeking evidence in an echo chamber

When faced with complex matters such as investment evaluation or political views, the data and evidence we gather is often imperfect. We accept or discard facts based on personal opinion rather than objective relevance, and our views often determine which data we seek.

Take the recent US presidential election, for example. Though there were no major economic events directly preceding or following the election, Gallup observed strong shifts in public perception of the US economy during that time. The direction in which those perceptions skewed depended on the political leaning of poll respondents.

Objectively, the condition of the US economy should not change in such a short timeframe, which suggests the influence of prior opinion. How the respondents felt about the election seemingly affected their response to the question.

Humans are biased to prefer information that conforms to our existing worldviews and avoid data that does not. Consider how rarely we read or watch news from sources that tend toward an opposing political viewpoint. A 2012 Pew Research poll indicates that just 10% of Fox News viewers classified themselves as liberal, while 32% of MSNBC viewers classify themselves as conservative.



Seeing what we expect to see

Not only do we struggle to gather adequate information, but we also tend to shape our interpretations of that data to fit our worldviews. When confronted with facts that directly contradict their convictions, humans tend to double down on their beliefs and ignore the evidence. Consider how often anyone actually “wins” that heated Thanksgiving dinner debate.

Rather than making a conscious effort to be open-minded as to where data and investigation take us, our rationale is often distorted by our desired result. In her excellent review of motivated reasoning research, social psychologist Ziva Kunda concludes, “People are more likely to arrive at conclusions…they want to arrive at.”

This human tendency is important to remember when reviewing the markets’ performance. Though equities largely performed well in Q1, the psychological lesson here is crucial: In order to objectively evaluate all the relevant data, you must first establish a complete methodological approach.


A healthy start to the year

Following last year’s presidential election, US stock markets responded positively, rising more than 10%. About half that gain came in the first quarter of 2017, with US stock markets up 5% since January.

image003(Chart illustrates the price history of the S&P 500 from November 8, 2016 through March 31, 2017; source: Google Finance.)

Though market performance and economic conditions are not always in sync, the US economy is healthy and the underlying economic data continues to improve. Unemployment nudged down to 4.7% in February and inflation has slowly risen to meet the Federal Reserve’s 2% target.

In mid-March, the Fed affirmed the general assessment that economic recovery is in full swing by bumping up its benchmark interest rate to 0.75%-1.00%. The stock market responded positively to the increase — the third of its kind since the Great Recession. Meanwhile, US fixed income — which is sensitive to changes in interest rates, inflation, and economic outlook — has been a stable store of value for bond investors through the first quarter.

In last year’s closing letter to our clients, we suggested that Republicans might move quickly to lower taxes on corporations and investors. Though they stumbled with their initial efforts to replace the Affordable Care Act, tax reform remains high on their agenda — which could be a positive development for some US investors. On the other hand, President Trump has suggested trade deal renegotiations, the longer-term impacts of which are uncertain.

Nonetheless, with a strong economy and the continued prospect of tax cuts, US stock investors should continue to see promising short-term conditions.


Opportunities and challenges abroad

Internationally, stock markets are also generally healthy, though Europe continues to face challenges and uncertainty, with looming elections in several major countries, lagging economic growth in several nations and negotiations regarding the United Kingdom’s exit from the European Union. International developed stock markets, including Europe and Japan, outperformed US equities, rising 7.5% in the first quarter of 2017.

image005(Chart illustrates the year-to-date price performance of VEA, an ETF tracking developed market equities, as of March 31, 2017; source: Google Finance.)

Last quarter, we noted that anti-trade and nationalistic sentiments in a number of developed countries might impede the economic growth of emerging markets. We also cautioned that though the US stock market outperformed other countries to close out 2016, it was a trend that probably wouldn’t continue. Disciplined investors who diversified their portfolios to lower expected risk and gain greater exposure to different markets were rewarded in the first quarter, when emerging market stocks averaged an 11% jump in value.

image007(Chart illustrates the year-to-date price performance of VWO, an ETF tracking emerging market equities, as of March 31, 2017; source: Google Finance.)


Committing to consistency

Remember, typical investors are inherently biased toward preferred outcomes in reasoning. We naturally want to find and accept information that aligns with our preconceptions. For example, you may hear that stock markets are doing very well across the globe and incorrectly conclude that shifting to a stock-heavy allocation is the best path forward.

The evidence remains, however, that a cautious approach is more effective, and investors shouldn’t try to time the markets. Asset class performance is seldom consistent or predictable, and economic challenges and pitfalls are inevitable. Though the US economy is strong and tax reform appears high on the Republican agenda, we don’t know the effect that trade negotiations, international elections, and interest rate hikes may have on investor portfolios.

Through careful consideration of relevant data, we can objectively evaluate portfolio performance and make informed decisions about how to invest for the future. This is especially important in today’s market environment, which is fraught with political influences and confusing economic data.

SigFig works to avoid these biases by using diverse and consistent sources to reveal the adequate depth and breadth of the underlying characteristics of the market. Whether markets are up or down, our investment team stresses objective analysis and a consistent methodological approach. In the coming quarter, our investment team continues to recommend a strategic, internationally diversified portfolio that invests in a wide array of asset classes to provide a balanced tradeoff of risk and return.

Aaron Gubin

Aaron Gubin leads research for SigFig’s Wealth Management team. He holds a Ph.D. in Finance and taught investments and portfolio management to graduate and undergraduate students before coming to SigFig. His research focuses on asset allocation, behavioral finance, and investment management.