Monthly Markets Memo - February 2019
by Dan Zalipski, CFA
The S&P 500 had its worst December since 1931 to close out the year. Fast forward a month, and you may be surprised to learn that the S&P climbed nearly 8%, its best January in 32 years. Dig a little deeper and it may not be that surprising at all to learn that some of the best market days are in close proximity to its worst days.
Attempting to avoid the bad days while catching the good days is nothing more than an attempt to time the market. It is ill-advised to time the markets’ natural gyrations. After all, the market experiences a 10% peak-to-trough correction about once a year, and it is all but impossible to predict when they will occur. The graph below from J.P. Morgan shows the potential impact of missing the best performing days to a $10,000 investment in the S&P 500 over 20 years. Missing just the 10 best days more than cuts your potential return in half. Furthermore, the graph highlights that 60% of the markets best days are within two weeks of the market’s worst days. Investors who get spooked out of their investments are susceptible to missing a recovery, with potentially devastating impacts. While market timing is clearly not favorable, neither is a set-it-and-forget-it approach.
Simply making your initial investments and never looking back is not a viable strategy to manage a portfolio. There is a difference between attempting to time the market for every sell-off and adjusting a portfolio’s broad allocation as the business cycle progresses. Certain sectors in both equity and fixed income tend to be favored at different points in the business cycle. For example, cyclical stocks tend to be hit harder during a recession compared to consumer defensive stocks, and the opposite could be said coming out of a recession. Beyond sectors, an investor can also find potential opportunities in adjusting the regional makeup of their portfolio as the U.S. business cycle is not necessarily in sync with other economies in both developed and emerging markets. A disciplined investor would exercise prudence in these decisions, tilting and adjusting a portfolio towards areas of opportunity rather than making concentrated bets with the real risk of permanent loss.
Investors should also focus on the long-term and do their best to avoid emotional reactions to short-term volatility. The fourth quarter is a good example. The Fed threw the market into chaos early in the quarter in forecasting aggressive interest rate increases. The selling was fierce, the market was falling, and yet the fundamentals remained relatively positive. Jobs numbers were surprisingly strong, workers were earning more, and inflation was contained. The market and the economic fundamentals were telling two different stories. When that happens, its best to focus on those fundamentals as they make up the components, such as earnings, that influence the markets direction over a longer timeframe.
Fundamentally the U.S. economy remains strong relative to the rest of the world. Manufacturing activity measured by the Institute for Supply Management rebounded from a sharp decline last month. January’s employment report easily topped forecasts adding another 304,000 jobs, although its worth noting that the previous 312,000 job report from December was revised down by 90,000. Even with that downward revision, the numbers are still exceeding what analysts were expecting.
Compared to the U.S., international markets are facing some headwinds. The U.K. is barreling towards an exit from the European Union without a deal in place leading to uncertainty around a wide array of policies, such as trade and access to markets. Germany’s growth rate is at a five-year low and their manufacturing sector is suggesting more pain ahead. Italy, Europe’s 4th largest economy, slipped into recession in late 2018. Looking East, China’s growth rate is at a 28-year low. China continues to transform from an export driven economy to one focused on their domestic consumer. They are attempting to engineer a ‘soft-landing’ after decades of debt-fueled expansion yet signal a willingness to deploy additional stimulus to support economic activity should it decelerate more than policy makers desire. We will continue to monitor for signs of international weakness bleeding into the U.S. economy.
Volatile markets are expected to be with us for some time. It is important to remember to maintain that long-term focus and allow time to be on your side. Be conscious of your own emotions and the impacts they can have on your investment decisions and be sure to consider the underlying fundamental drivers of the economy. Next month we’ll look at this quarter’s earnings, and what these companies see looking forward.
"The individual investor should act consistently as an investor and not as a speculator." - Ben Graham
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to, nor does it represent or reflect, transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.