After
years of advancing without so much as a 10% correction, investors were recently
reminded that in the short term, markets can go down as well as up. The S&P 500 Index fell by more than 6% in
August and that was followed by a 2.5% decline in September. Gains in July combined with those declines to
produce a total return of -6.4% for the S&P 500 in the third quarter. Large U.S. stocks had it easier than others
as third quarter returns were -11.9% for US small stocks (Russel 2000 Index),
-10.2% for established international stocks (MSCI EAFE Index), and -17.9% for
beleaguered emerging market stocks (MSCI EM). The blended equity index we
generally employ (60% large US, 15% small US, 15% established international,
and 10% emerging stock markets) produced a negative 9.0% total return in the
third quarter and a negative 6.6% return this year to date.
Even
though bond yields are famously low (yielding barely over 2% for the 10 year
U.S. Treasury as of this writing), bonds performed their usual role as a safe
haven in the third quarter and returned just over 1% (which is, on an
annualized basis, about double their expected long-term return from here).
Your
“market risk hedge” positions performed quite well, generally rising about 0.4%
in the quarter (and nearly 1% this year to date), fulfilling their intended
purpose as portfolio diversifiers.
Inflation
hedges mostly declined in value amid the perception that inflation threats have
further receded. You haven’t likely seen
headlines trumpeting this, but year-over-year change in the CPI has actually
been slightly negative in 5 of the past 8 months.
Publicly
traded real estate generally held up much better than stocks in the third
quarter, but year to date hasn’t been so different with a return of negative
4.5% for the REIT index.
The
current stock market correction and its accompanying elevation in market
volatility appear to have been considered unusual by many observers, but, as
we’ve said previously, the most unusual thing about them has been the
abnormally long gap since the last market correction and meaningful
volatility. Stocks offer greater returns
than bonds because of the greater uncertainty surrounding their returns, or in
other words, because of the greater volatility of their shorter term price
movements. If stocks didn’t have these
otherwise undesirable traits, they would be priced to offer no better returns
than bonds. Periodic market staggers and
shakes just go with the territory of stock investing and in fact, do produce
benefits. We certainly don’t know when
this episode will pass, but we do know that long-term returns from this point
will likely be marginally higher going forward.
We have, of course, been net buyers of stocks and net sellers of bonds
during this late summer “sale” for stocks, and we will do so more aggressively
should the bargains improve.