My F&M

3rd Quarter 2017 Market Commentary

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Major stock market indexes posted robust performance in the third quarter, extending strong returns in the first half.  

The S&P 500 index of large US stocks returned 14.2% this year through 9/30, developed international markets returned nearly 20%, and emerging markets over 27%.  Domestically, small US stocks lagged a bit but returned nearly 11%, and value stocks under performed “growth” stocks by nearly 13%, value’s worst relative performance in seven years (this is relevant since, as you know, we tilt toward value).  Taxable bonds returned 3.2% this year through the third quarter.

We have written much about how stocks have been expensive, and that condition remains, reducing long-term market return expectations, especially in the US.  Expensive markets also magnify shorter-term risks including the North Korea situation, Fed tightening, unexpected inflation, and other concerns.  On the other hand, inflation and interest rates have remained low, corporate profit margins are high, economic growth appears to be accelerating, and renewed expectations for corporate tax reform raise the prospect for stronger growth ahead. 

Rather than dwell on how expensive stocks are, this time we would like to point out an additional, but related condition: low volatility.  Not only have recent returns been better than we may expect in the long run future, but those strong returns have also occurred in a more stable manner than history says should be likely.  There are many ways to measure this, some quite complex.  But a simple and intuitive one is this: the third quarter of 2017 marked the eighth quarter in a row of positive returns for the S&P 500, something that has not happened in 20 years!  Higher returns than normal are one thing, but higher returns without any appreciable dips along the way are quite another with respect to lulling us into complacency.  That just means that the market’s next correction, whenever it may occur, may feel worse than it actually is, since we have all been “spoiled” by recent market history.  Occasional market scares are a part of investing, and stocks would not provide better long-term returns than bonds if they didn’t also entail more risk.  The near absence of market volatility of late is no reason to believe that market volatility has permanently vanished.

Some things, such as the relationship between risk and return, are core market features that may ebb and flow in the short-run, but which are ever-present in markets in the long run.  Other things, such as access to certain diversifying asset classes, may evolve and even improve over time.  One thing about markets that has changed over time for the better are improved indexes, which better reflect markets.  One index which has been around for some time, but which has appropriately been gaining in usage recently, is the MSCI ACWI Index.  MSCI stands for Morgan Stanley Capital International, and ACWI is its All Country World Index for stocks, representing the top 85% of each developed and emerging stock market around the globe.  It includes 2,400 stocks from 47 different countries and is weighted by “market capitalization” (the dollar value of all a company’s shares).  An “international only” version of this index, the “ACWI ex-US” index is increasingly considered to be the best representation of how stocks outside of the US are doing.  We have previously used two different indexes to measure various parts of that – the MSCI EAFE index for developed markets and the MSCI EM index for emerging markets – but the MSCI ACWI ex-US index is simpler and increasingly used in the industry.

Similarly, the Russell 3000 index of US stocks is a more complete representation of US stocks and is simpler than the combination of the S&P 500 index (for large stocks) and the Russell 2000 index (for small stocks).  The Russell 3000 index is a market capitalization weighted index of the largest 3000 US stocks. 

The opening paragraph of this piece referenced stock market returns from large US, small US, established international, and emerging international stocks.  The four stock indexes that we have relied on to measure these markets have been the S&P 500 index, the Russell 2000 index, the MSCI EAFE index, and the MSCI EM index.  Going forward, we expect to lean more heavily on the MSCI ex-US index for international stocks, the Russell 3000 index for US stocks, and to a lesser degree, the MSCI ACWI index for global stocks.  These are simpler, increasingly more accepted in the industry, and more representative.  Here, we just wanted to introduce these indexes, but we will expect to offer more education about these market benchmarks in the future.