The last few months have been uncertain times for U.S. investors. After years of marching relentlessly higher, U.S. equity market growth has pared to a modest 3-4% since the end of 2014. In spite of the modest recent performance of US equities, many investors feel that many asset classes are “expensive.”
Investors have many questions: has the U.S. stock market peaked? When will the central bank begin to increase interest rates? What are the prospects for emerging and developed markets? We will discuss these questions, and their implications, below.
More than anything, investors are probably wondering what they should do. We strongly believe that in times like these, investors need to stay the course, with a diversified portfolio that has the risk-appropriate mix of equities and bonds. The markets could be poised for a pullback — or for several more years of growth. Adjusting a portfolio in anticipation of future market movements usually underperforms a long-term strategic allocation held through market cycles.
For the U.S. stock market, mixed signals
Throughout the last several quarters, signs of a sustainable, healthy U.S. economy have been mixed, leaving investors with lots of questions about the future. Unemployment is still trending down, reaching 5.4% in April. However, continued slack (excess capacity) in the labor market has left wages stagnant throughout the recovery, with few signs of future increases. Inflation remains below 2%, and company profits, which had reached all-time highs in 2013, abated slightly in 2014.
These signals have led U.S. equities in a mostly sideways trajectory for the last several months, with little clarity promised on the immediate horizon. Though U.S. stock market indices have hit all-time record highs, there aren’t major structural issues in the economy that should derail continued stock market increases.
(S&P 500 performance for the 12 months ending May 19, 2015.)
Timing uncertainty over interest rate hikes
Fixed income markets remain high as central banks around the world keep interest rates at historic lows. The Federal Reserve will eventually bump their benchmark lending rate up, pushing bond values down. However, the timing of the rate increase remains uncertain. Though Fed watchers think the central bank will nudge their benchmark rates higher as early as September, the last two quarters produced annualized GDP growth of just 1.2%. Perhaps this tentative performance may lead the Fed to postpone their rate hike.
Continued growth for developed markets
In contrast to the United States, developed markets have performed well over the last six months, as major central banks around the world initiated monetary easing policies and international economies emerged from recession. Debt concerns among many southern European nations (Italy, Spain, and Portugal) receded, though Greece’s fate as part of the Eurozone remains uncertain. Even with global political issues weighing on markets (e.g., Ukraine-Russia border skirmishes and Iranian nuclear negotiations), prospects for continued growth among international economies appears strong.
(12-month performance chart of EFA, an index fund tracking the MSCI EAFE Index)
Emerging markets uncertainty
Meanwhile, emerging markets have also bounced back from weaker showing in 2014, with help from an uptick in oil prices and interest rate reductions in China. Nonetheless, future growth is uncertain as global demand for oil and emerging economy exports fluctuates.
The importance of staying the course in a diversified portfolio
When there is uncertainty on the horizon, a balanced, well-diversified portfolio is what investors need, as it enables profit in upward markets and protection against downward movement.
It makes good investing sense to avoid tactical market timing, because adjusting a portfolio in anticipation of future market movements usually underperforms a long-term strategic allocation held through market cycles from top to bottom and back. It’s better to hold a risk-appropriate portfolio for the long run than sit on the sidelines hoping to avoid an imminent crash, while the market continues a strong run.
As always, it’s important for all investors to confirm regularly that their portfolio allocation matches their risk tolerance, enabling them to ride fluctuations that affect any specific asset class.
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.