There is no shortage of free-floating anxiety in the investment world or, more broadly, in the world-at-large. But you may find it helpful to look at the evidence to get a better gauge on what’s really going on in the world. Let’s take a closer look at some macroeconomic indications of what’s happening this fall.
U.S. Growth Continues, But Slowing
Second quarter gross domestic product (GDP—a measure of economic growth) was 4.2%. This is higher than the first quarter (2.2%) and likely due to a tailwind from the tax law change. Most experts think this will level out at around 3% to 3.5%.
We are in the late stages of a very long bull market. And we are seeing more normal volatility in the U.S. stock market this year. Last year was unusually strong. Don’t expect that this year. When you look at returns from a balanced portfolio year-to-date, they will be flatter and more typical of what we expect in a late-stage market despite the U.S. stock market hitting new highs.
Whenever stock markets are going strong, there will be some tough decisions to be made. Look closely at any individual stocks to see if they need to be pared back. It’s time to de-risk, but subtly and slowly. Consider taking capital gains on positions that have grown tremendously over the past ten years. Paying tax may be the best answer when weighing an overly risky portfolio. But use tax-sensitive strategies to do this intelligently.
Trade issues continue to be a concern, but when you look at the true impact of this escalating, it doesn’t seem to have a large impact on the U.S. stock market. It could push up inflation somewhat, but many experts think this will resolve itself in the next six months or so.
Caution Advised Internationally
Part of what is pulling back overall balanced portfolio returns is the international allocation. The strong dollar this year has hurt international returns. (Last year was also very strong for international stocks, especially emerging markets.)
Does this mean we want to avoid international stocks? No! Longer-term we want the growth that broader global markets promise. We need to take a longer view of where we see pockets of opportunity.
Fed Continues Rate Increases
The Fed raised interest rates again 0.25% in September. There are also signs that rates will probably rise again in December and perhaps 2-3 more times in 2019. Now in the long-run, this is good. Interest rates on bonds and CDs go up. But in the short-term, this can pull down total returns from bonds. If you look at returns on bonds year-to-date, they are also very flat. If you stay relatively short (under ten years typically), you’ll see bond returns slightly negative (maybe slightly positive in some cases). When we think about future bond returns of a conservative fixed-income portfolio, we estimate we should see something in the 2% to 3% range.
Does this mean we don’t want bond exposure? No! We need those bonds for both income and stability. Stocks may drop 20% (the definition of a bear market) and it could occur in the next two years. That’s just normal for the stock market cycle. So we want those bonds in the portfolio and we need to be patient investors to let diversification provide the smoothing effect we need in varying markets.
We do think that the flat yield curve means there is less compensation for taking risks—from either duration (the time-weighted maturity of a bond) or credit quality. So we are typically holding CDs or high-quality muni bonds (short- to intermediate-term durations).
Diversification Still the Key
Economists are predicting that the next recession could be “wok” shaped. That means it could be shallower, but perhaps longer, than some cycles. No one knows when this will occur, but it could occur in the next two years and many economists believe it is likely in the next two years. Ben Bernanke, the former Fed chair, describes the next recession as Wily E. Coyote running off the cliff with his legs still spinning until he looks down and then falls.
So what should we do? Stay the course. Stay diversified. Perhaps add in some alternative asset classes that are not directly correlated with the U.S. stock market. Look for pockets of opportunity. The evidence suggests the economy is sound and you want to build a portfolio that is built to withstand a more normal level of volatility.
The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.