Comparing the investment landscape of 2014 versus what we have experienced so far in 2015 is a very good lesson in the benefits of diversification. In 2014, an investor only needed to have a portfolio comprised of two asset classes, the S&P 500 and high quality intermediate- to long-term bonds, to generate the “best” returns. The S&P outperformed other sectors of the equity markets by a large margin with developed international and emerging market equities actually posting negative returns. The Barclays Aggregate Fixed Income index also posted strong mid-single digit returns despite continuing fears of rising bond yields.
This year has been a completely different story. The S&P 500 lags MSCI EAFE (international developed stocks) by almost 5 percentage points, bonds have provided little return and increasing volatility and other things that underperformed in 2014 (international REITs, absolute return fixed income, some hedged strategies) are providing value to portfolios in 2015, either through enhanced returns or reduced risk (volatility). This is a validation of our strategy of building panoramic portfolios with many risk and return opportunities and acknowledging that trying to time the market is difficult if not impossible to achieve over the longer term.
We are halfway through 2015 and many equity indices (S&P 500, NASDAQ, S&P 400 and S&P 600) have touched record high levels. That fact, coupled with concerns over the Fed raising rates off of 0% (where they have been since 2008) have many investors anxious. Add in Greece, the collapse in oil prices, and the general slow growth of this recovery and many investors feel that the market is “high” and vulnerable to a decline. While a correction is inevitable at some point and a relatively normal occurrence, we don’t feel the conditions are currently in place for a 2008 type of market environment. Monetary policy remains very accommodative and will likely continue to be even as the Fed begins increasing the overnight rate; valuations are not extreme, investors are skeptical, and the most recent Fed statement acknowledged several improvements, most notably in labor markets. We believe strongly that markets are most vulnerable when valuations are stretched, and investors are euphoric, thinking, “This can never end!” Those don’t appear to be the current conditions.
Forecasting market returns, particularly in the short term is a loser’s game. Instead, we would acknowledge that after a very strong 6 year run for equities, and with the prospects that 0% interest rates will end sometime later this year or next (and QE is already wrapped up) that looking out over the next period (five years +/-), returns will be lower than the last six and lower than historical averages. Point to point over that timeframe we would expect positive returns but they will be lumpy with the possibility of a negative year or two. Mid to high single digit returns for equities and low single digits for bonds.
Our best financial advice is to continue to diversify based on your own asset allocation mix, rebalance to take advantage of market volatility, and most importantly, have realistic saving and spending policies. And, as always, your Moneta team is here to help answer any questions.