Over the last few years, our quarterly reports held a reassuringly simple theme: if you properly set your risk tolerance and remain invested in the markets through its ups and downs, you will be rewarded.
This advice was undoubtedly challenging to follow over the last twelve months, especially while the U.S. stock market experienced an intraday drop of 7% last August and a 14% decline in February. Throughout the period, though, we have stressed that investors are wise to remain invested as the fundamentals of our present economic growth have not changed.
Most recently, in the wake of the British decision to leave the European Union or “Brexit” vote, we wrote that “markets will adjust and recalibrate.” Though the vote to leave was unexpected, we did not see fundamental economic changes, though we anticipated increased volatiltiy and a short-term decline. In the months since, international and domestic markets have bounced back and then some; in fact, US markets are at all-time highs.
As the accompanying chart of the S&P 500 shows, the U.S. markets have experienced significant ups and downs since 2014, but the patient investor who ignored most of the news and remained focused on the long-term is up a total of 18.6%, or approximately 6.7% per year.
The U.S. economy has plenty of positive indicators: restaurants and shopping malls are filling up; unemployment is down to 4.9%, and inflation of 0.8% remains well below the Fed’s 2.0% target. Meanwhile, wages are increasing faster than inflation, meaning that workers have more real dollars to spend, save, and invest. Oil prices rebounded to $50 per barrel after sinking below $30 in the winter, with varying impacts on consumers and different industries; for example, energy companies are typically more profitable with higher oil prices, while airlines fare worse given their reliance on fuel. We expect the Federal Reserve will continue its patient approach to interest rate hikes, though that could nonetheless include an additional quarter point hike before the end of the year.
Internationally, developed economies continue to search for solid economic footing. Though interest rates in several major developed countries are negative, Japanese and European stock markets have bounced back from the spike immediately following the British EU exit vote. There are also bright spots; emerging markets have bounced back on renewed strength of commodities and currencies, as this chart of the FTSE Emerging Market Index ETF, VWO, illustrates.
(Chart illustrates the price history of the Vanguard FTSE Emerging Markets Index ETF, VWO; source: Google Finance)
Our guidance remains constant: continue to stay steady over the near term. Confirm your portfolio’s risk is well matched to your investment horizon. (Retake our risk questionnaire to make sure your risk tolerance is set correctly!) Uncertainty will always be a part of investing; we watch some predictable events with interest, though we also remain alert for the unexpected. As election season progresses here in the United States and we move into the fall, we anticipate investors will price in expectations about the election’s outcome while the economy continues its steady growth. At SigFig, we remain committed to delivering a globally diversified, strategic portfolio that provides exposure to many asset classes.
Last night, the British voted “Leave” on their referendum to exit the European Union (EU). This result is poised to increase uncertainty and weakness within the union of 28 countries.
SigFig’s Investment Team expects increased volatility in global markets, as investors assess the impact of the vote. Though there are likely to be few immediate economic consequences, many European economies, and especially the British, are likely to suffer from weaker connections to the Continent, with global impact.
What should you do?
Focus on the long-term and ignore the short-term market fluctuations.
Markets will adjust to the Brexit result and recalibrate. Meanwhile, it’s important to recognize that a globally diversified, asset-class diversified, time-horizon appropriate portfolio will weather this storm. Your SigFig portfolio is designed to invest your capital wisely to endure the ups and downs of market volatility.
With the uncertainty about global economic growth caused by the Brexit result, international markets are likely to decline. Meanwhile, U.S. Treasuries are likely to be a source of safety and could rise as investors seek to relocate their capital to more stable assets.
SigFig portfolios deploy assets in all major markets, including the U.S., Europe, Asia, and points in between. Moreover, the portfolios contain U.S. Treasuries, investment-grade bonds, and other sovereign debts for asset-class diversification, while accommodating different risk levels and different investment horizons.
If in doubt about whether your portfolio is matched to your time horizon, retake our risk tolerance questionnaire.
P.S. With the British pound falling in value relative to the U.S. dollar, now is a great time to visit England!
It’s hard to love a good bull market—if you’re out of the market, invested in cash or other assets, it’s frustrating to wait on the sidelines for better buying opportunities. You see the neighbors enjoying the gains, but you’re stuck in place. Meanwhile, if you’re fully invested, you’re always on edge that the bull market will give up the ghost. Should we stay in, should we get out?
Prior to the current run, dating back to 1932, there were eleven bull markets, lasting an average of five years. But we’re nowhere close to the longest yet; the run from December 1987 to March 2000 lasted more than 12 years.
Our view is that you should ignore all of this. If you think appropriately about your investment time horizon, you should invest your assets in a mix of stocks & bonds and ignore the intra- or inter-year fluctuations in the market.
If you’re out of the market because you’re afraid or you have a shorter horizon, you should invest in a healthy mix of investment-grade bonds (fixed income), with a smaller but still meaningful allocation to globally diversified stocks. If you have a short horizon, make sure you’re taking sufficient and appropriate risks.
Where do U.S. markets stand today?
The US stock market remains on a tremendous seven-year run from the depths of early 2009. Equities wobbled for the first six weeks of 2016, down nearly 10%, but rebounded completely by the end of March.
S&P 500 performance from January 4, 2016 to April 6, 2016
Even with this volatility, it has continued to prove very hard to be a good stock picker. Fewer than 20% of large-cap active managers beat the S&P 500 in the first three months of the year. The experts do not reliably beat their benchmarks, and even acknowledging that they win sometimes, they on average do not do so by sufficiently large margins over the long-run to justify paying their high management fees.
As a result, we recommend a more strategic approach: buy low-cost index funds, diversify your investments across many asset classes, and patiently take the long-view. This is the SigFig approach: we invest our clients’ assets in diversified portfolios that make sense for their financial goals and time horizon.
International markets: slow growth, choppy markets
On the international front, developed economies are still growing, albeit very slowly. Weakness in these economies has been met with European and Japanese versions of quantitative easing as central banks attempt to stave off recession. Though they have not yet completely rebounded from the early 2016 swoon, developed international markets cut their losses over the last several weeks.
Meanwhile, emerging markets hit hard by declines in commodity prices have stabilized. The skid in oil prices has stopped, but low commodities prices have kept a lid on economic growth. Nonetheless, emerging markets stock performance bounced back after falling off more than 10% to start the year.
(Chart illustrates the price return of VWO and VEA. VWO is the Vanguard Emerging Markets Equities Index ETF; VEA is the Vanguard Developed Markets Equities Index ETF; measured from January 4 to April 6, 2016.)
The future is unpredictable, so it’s wise to have exposure to many different markets. The SigFig strategy is to diversify its clients’ assets across the globe, with exposure to both developed and emerging markets.
Fixed Income: interest rates are going to rise, but possibly slower than you think.
At the end of 2015, the Federal Reserve announced its first rate hike in seven years. Since then, the question remains how quickly the Fed will continue to raise rates to bring them in line with historical norms.
(This chart illustrates the price return of AGG, the iShares Investment Grade Fixed Income Index ETF from January 4 to April 6, 2016.)
Fed Chairwoman Janet Yellen indicated in her February congressional testimony that the Fed will increase rates slowly, but it appears reluctant to push too hard on interest rate hikes at the risk of stalling out the US economy. Related to these muted expectations about rate increases, investment grade fixed income prices continue to creep up, as market observers temper their expectations about future rate changes.
Stay appropriately diversified; focus on the right time-horizon
As we have consistently stated, the SigFig approach is to stay committed to a diversified portfolio whose risk is appropriate to your investment horizon. Identify the right mix of asset classes to deliver the right amount of return to meet your investment goals while not too risky for your personal comfort. (Retake our risk questionnaire to make sure your risk tolerance is set correctly!) Then invest in low-cost index funds that give the exposure to a broad set of securities within an asset class. This is the research-backed way to build your investment portfolio.
Worldwide, stocks have fallen significantly and volatility has increased in the early weeks of 2016.
The hardest part about being a disciplined investor is maintaining a patient, thoughtful approach in the face of market headwinds. It’s tempting to sell your portfolio and wait out the storm, at least until things seem to have settled down.
Some investors hit the panic button, liquidate everything, and wait. When people make investment decisions based on fear, however, they abandon the smart, calm approach that should guide their rational long-term planning.
This is a good chance to consider the opportunities available to long-term investors. Modern portfolio theory suggests that the smart, long-term approach is to stay the course.
Though the S&P 500 has had a correction of approximately 10% in the last month and international markets are off 10% to 20%, diversified portfolios with stocks and bonds have been less impacted than concentrated portfolios. This presents excellent opportunities to invest (and reinvest) in a globally diversified portfolio.
Though it’s natural to want to pull out when the market gets volatile, it is impossible to know where the bottom is. Frequently, market timers withdraw at the bottom, already absorbing all of the losses. Other times, they attempt to buy back in at what they think is the bottom, only to see the market fall further — what is known as “catching a falling knife.” Then, once the fear factor has been initiated, it is hard to anticipate the market’s upswing, building the courage to reinvest while getting the re-entry timing correct. In fact, research shows that market timing generally underperforms a buy-and-hold, disciplined approach. Simply riding the swings, even the volatile ones, outperforms active investing and market timing.
As an example, the chart below shows the S&P 500 over the one-month period from July to August 2011. The S&P 500 fell almost 15% in the month. The market had been on a tear through mid July, up 50% from its 2009 lows.
If you jumped out of the boat in August 2011, nervous that stocks were overvalued, you’d have missed a big chunk of a great market rally. Over the next three years, the market was up 66%.
The research says stay the course. Don’t try to time the market. Invest in a diversified portfolio, reconfirm your risk tolerance, and harvest available tax losses.
- Don’t try to time the market. Attempts to time the market, by jumping out at initial signs of market tops, or jumping in at signs of market bottoms, underperform a disciplined, buy-and-hold, stay-the-course approach. Most finance research indicates it is nearly impossible to figure out where the market is going (minutes, days, weeks, months, or years from now). It is impossible to know if the markets will move higher in the coming days or continue with volatility. Even the so-called experts do not beat the market reliably. Still, markets historically reward smart, disciplined risk-taking over the long-term: investors take on risk by investing in companies and are rewarded with capital gains and dividends.
- Invest. We strongly advocate setting up regular, recurring deposits. These serve several purposes. First, they build your account value, getting more of your assets to work for you. Second, deposits enable a simple rebalancing of your portfolio to pick up small relative under-valuations between asset classes. Finally, they enable you to invest when the market has experienced a larger decline. These factors combine to lower your portfolio volatility and your overall risk.
- Confirm your risk tolerance. If you’re watching the market downturn nervously, it’s a signal to rethink your risk exposure. Visit our Managed Accounts page to retake your questionnaire and see if your portfolio’s risk level matches your current comfort with market volatility. Your portfolio should be aggressive enough to achieve the long-term returns you want, while still enabling you to be comfortable living through short-term market pullbacks.
- Harvest tax losses. Our investment team carefully reviews market conditions for opportunities to reduce your taxes. We automatically look for conditions to lock in a lower cost-basis and capture tax losses for our clients, who can use that loss to offset other gains (and even income) to reduce their taxes. We purchase a similar asset class ETFs so our clients remain fully invested for a market rebound. If you haven’t turned on Tax Loss Harvesting, you can do it now by clicking here. If you want to learn more about Tax Loss Harvesting, visit our FAQ.
At SigFig we work to deliver the optimal investing tools and asset management services for our clients and their portfolios in any market conditions. Volatile markets can frighten even the most seasoned investors, but with the right tools and investment partners, even a market downturn can be an opportunity to invest better.
One of the interesting challenges in studying investor behavior is accounting for the notion of cognitive dissonance, which describes the difficulty of weighing two contradictory ideas at the same time.
Consider how you would describe yourself. Are you a nice person? As you reflect on the affirmative, you might also remember a time when you acted with indifference or even cruelty, bringing about an uncomfortable feeling as you ponder this seeming contradiction; I think I’m nice, but I’ve also done some not-so-nice things.
As a behavioral “problem,” people often manage this uncomfortable feeling by ignoring or disregarding information that conflicts with their preferred view. Put differently, we usually dismiss the memories of our being unkind in favor of our positive self-image. The problem is obvious; by filtering the information to align with our preferred perception, we have an incomplete picture of a complex reality.
This filtering affects our worldviews, too. Consider your view of the U.S. economic recovery. Has there even been one? For many, the recovery has not improved net wealth, job prospects, income, or confidence in the future. Recent presidential debates have focused economic discussions on the economy’s weakness.
Yet by nearly every statistical measure, the U.S. economy is strong and growing; the stock market has enjoyed a bull run for more than five years, unemployment is down to 5% (with college graduate unemployment down to 2.5%!), inflation remains under 2%, the dollar is at decade highs against the euro and the yen, and companies report record earnings. Nevertheless, many believe that the economy continues to struggle, perhaps inspired by weak wage growth.
The truth is somewhere between. One feature of this economic recovery continues to be a general shift towards higher-skilled jobs. Without marketable skills, education, and flexibility, many people have been left behind. Meanwhile, the recovery has delivered significant gains to investors, the highly educated, and flexible-work employees. The U.S. economy is expanding, but consumers are suspicious of the recovery’s underlying strength. Even though the stock market remains near all-time highs, our perceptions of the economy reflect this cognitive dissonance.
In spite of anecdotal evidence suggesting a weak recovery, most statistical analysis indicates the U.S. economy is strong: job creation has increased while inflation remains low. Following the late August stock market hiccup, the benchmark U.S. S&P 500 Index is up nearly 10%.
(S&P 500 Index performance 8/26/15 – 11/17/15. Chart from Google Finance.)
Meanwhile, U.S. bonds remained stable through October, as the Fed continues to defer a rate hike. With a great jobs report and continued evidence that inflation remains low, expectations have grown that the Federal Reserve will nudge the benchmark overnight rate by a quarter point, though we prefer they resist the temptation. Why? The risks facing the economy are asymmetric: there’s less chance that the economy overheats in the next quarter than falters.
A deferred hike provides the Fed with more opportunity to gauge macroeconomic impacts. Though the US’s economy is strong, many of the country’s international trading partners face concerning weakness, potentially slowing domestic growth. Further, where the Fed might typically raise rates to combat increasing Inflation, the evidence indicates inflation remains remarkably low. Finally, a quarter-point signal move does little to provide “ammunition” for the Fed if it faces sudden weakness; better to keep the rates low a little longer and maintain a watchful eye than risk slowing an economy that doesn’t show signs of overheating.
Developed international markets have been volatile, up about 3% after tumbling by 9% during the worldwide correction at the end of August.
(3-month performance chart, ending November 17, 2015 of IEFA, an ETF tracking the MSCI Developed Markets Index. Chart from Google Finance.)
The European Central Bank began a version of quantitative easing to offset austere fiscal programs, which weakened eurozone economies. The British economy has also slowed. The Japanese economy reentered a recession in spite of more aggressive government spending, as a shrinking workforce struggles to sustain output. More broadly, the outlook for Europe remains unclear — the success of the a single economic zone has been repeatedly tested over the last few years, with debt issues across the southern half of the continent, suggestions that Greece drop out of the currency union, and questions about how to handle the influx of Syrian refugees.
The lack of synchronicity between the Fed and other central banks have interesting consequences for global markets. The minutes of Fed meetings and speeches given by various policymakers suggest that the US will be first to raise rates among the major central banks. This action has already led to a strengthening dollar as international investors transition to dollars. Meanwhile, emerging markets are at risk of getting trampled as the dollar strengthens against other currencies.
Emerging markets have stabilized somewhat after being hit hard by three factors: a) an economic slowdown in China has led to lower demand for construction supplies, including commodities; b) global decrease in commodity demand has softened prices; and c) weakness in many developed nations reduced trade. Oil prices have collapsed from 2014, down nearly 60% this year.
The chart below shows the relative performance of IEFA and GSG, ETFs tracking an emerging markets index and a commodities index, respectively.
(6-month performance chart, ending November 17, 2015 of IEMG and GSG, ETFs tracking the MSCI Emerging Markets Index and the S&P GSCI Commodities Index. Chart from Google Finance.)
Returning to the notion of cognitive dissonance, we have lots of conflicting information about the state of global markets, but we should avoid filtering to fit our preferred worldview. Markets around the world remain in a state of flux; smaller U.S. companies have done well, while large-cap U.S. stocks and developed markets tread water in 2015, and emerging markets declined significantly. This state of uncertainty is exactly the reason it is valuable to be globally diversified in many asset classes.
Diversified portfolios help us manage conflicting information; we remain exposed to multiple opportunities while reducing the risks associated with the ups and downs of market moves. This is especially important when markets yield conflicting information and do not always move in the same direction.