May offered investors a bumpy ride, to say the least. We saw the global stock market pull back by over 5%, its worst performance since late last year. Trade fears were yet again at the forefront of concerns as talks for a deal with China fell apart in mid-May. China then responded with retaliatory tariffs, and whatever hope remained for a near-term deal disintegrated.
To add to the mounting trade concerns, President Trump announced a 5% tariff on Mexico that will go into effect on June 10 unless the Mexican administration takes action to curb illegal immigration into the U.S. The Mexico tariff announcement came shortly after the President took steps to push forward with the U.S.-Mexico-Canada trade agreement (USMCA).
Is It Time to Get Worried?
It would be disingenuous to say that the current environment is not concerning. While we do not make predictions about what will happen in geo-politics or if and how certain policies will impact economic growth, it’s hard not to worry about the impact a trade war with multiple major trading partners could have across the globe.
In the face of uncertainty, our advice is to maintain discipline in a long-term strategic portfolio allocation. But we know that there are other voices out there competing for investors’ attention and recommending courses of action that will supposedly increase chances of success for what lies ahead. Let’s explore some of those options and why we remain steadfast in our advice.
Option 1: Pick Stocks That Will Outperform
Theoretically, if you know what is going to happen with tariffs, then you could pick stocks of local U.S. companies that benefit from tariffs and sell stocks of those companies that will be hurt by tariffs. It sounds simple, but in practice the odds of successfully implementing this type of strategy are very low. Why? In today’s globally intertwined economy, it’s very difficult to find firms that are pure-plays in standing to benefit or be hurt by single-country tariffs. That is because the supply chain for most firms is global, and trade is multi-lateral, not single-country.
To further complicate matters, what will happen in the future and the timing of the activity is difficult to predict. Since last year when the talk of the tariffs first began, the situation has changed often — which goods from which countries will be subject to tariffs and who trade deals will ultimately be negotiated with has shifted from week to week.
As an example, if you traded while China talks were optimistic, you would be holding the “wrong” target portfolio when they fell apart. The result for an investor pursuing this type of stock-picking strategy is a portfolio that is being churned from day to day and is generating high trading costs that in themselves worsen the odds of achieving market-beating returns.
Finally, the market as a whole tends to incorporate new information rapidly, and trading ahead of the market when new information comes out is nearly impossible. A low-cost diversified portfolio that holds the entire market might not win every week, but over the long-term, it places you in a much better position to achieve your goals.
Option 2: Get out of the Market and Wait It Out
When uncertainty strikes, the temptation to pull out of the market and wait out the storm can be very real. Some investment managers and TV gurus make “going to cash” seem like a viable option. What we know is that markets go up and markets go down, but they tend to go up more often than they go down. Predicting the right time to get in and out is difficult.
Periods of high market volatility (when there is a great deal of uncertainty) are some of the times when investors earn the highest returns and are rewarded for their discipline. The chart below shows that nine of the 20 worst trading days between 1980 and 2017 occurred in calendar years with positive returns. Getting out of the market at these times can cause an investor to lose out on subsequent strong returns. Another often overlooked consideration is the tax inefficiency and additional trading costs that are generated from pulling in and out of the market.
Timing the Market Is Futile: The Best and Worst Trading Days Happen Close Together
S&P 500 Index daily returns, December 31, 1979, through January 31, 20181
Option 3: Stay Diversified and Stay Invested
Many investors forget that staying invested and sticking to their plan is an active decision. Making frequent changes to a portfolio allocation in response to short-term market events can prevent an investor from earning long-term returns, and we see that borne out in the data on market returns versus investor returns.
Additionally, a well-diversified portfolio ensures that investors have exposure to all the stocks in the market (including those that perform well in response to policy changes). Because policy changes and geo-political shifts are so difficult to predict, a diversified portfolio remains an investor’s best defense in the face of uncertainty.
Achieving Your Long-Term Goals
As with any difficult month in the market, we do not make light of the very real concerns that investors have. The overwhelming academic evidence shows that staying the course and remaining diversified is the best approach.
If you have any questions about market volatility or investment strategies that can help you achieve your long-term goals, please contact an advisor at Wipfli Financial.