Reflecting on Recent Market Volatility: Why Discipline Is Still Your Best Defense

We experienced another rough patch in the market last week. A trade truce with China appeared to be a welcome development last Monday, but then many investors grew concerned that a trade agreement would not be reached within the agreed-upon 90-day time frame, and yield curve inversion fears set in.

We don’t make changes to portfolios based on these short-term market events — which are nearly impossible to predict — but we realize they can be unnerving. During periods of market turbulence (like we have experienced this year), we proactively evaluate portfolios to see if there are opportunities to harvest losses and improve after-tax returns. As 2018 comes to an end, and to provide some context around this volatile year, it may be helpful for you to understand what has been happening in the economy and the market.

Let’s Start With the Economy

Volatility in the stock market notwithstanding, the U.S. economy has been extremely strong this year. In the third quarter, U.S. GDP grew by 3.5% on an annualized basis, declining from a record 4.2% growth rate in the second quarter, and GDP growth is on pace to reach 3% for the year.1 GDP growth was spurred by strong consumer spending and an increase in government spending because of fiscal stimulus. Despite last week’s job report, which showed that hiring slowed down in November, unemployment remains at a multi-decade low of 3.7% and wage growth is up 3.1%.2  Backed by the tailwind of tax reform, companies received an immediate boost to their bottom-line earnings with S&P 500 companies expected to report earnings growth of over 20% for 2018.3 Not only have we seen an uptick in profitability this year, but revenue for these companies also is estimated to increase by +6.7% in 2018.4

Given that economic growth has been so strong, you may be wondering: what is bugging the market? The stock market typically is considered to be a leading indicator of the economy, whereas GDP numbers and statistics are backward-looking. The market assimilates investors’ expectations of what companies’ prospects are for the future. While the good news on the economic front is welcome, many of the pullbacks we have seen this year have been associated with concerns around future growth prospects.

World Stock Market Performance5

MSCI All Country World Index with selected headlines from past 12 months
Short Term (January 1, 2018– December 7, 2018)

Tariffs and Trade

This year’s first big pullback in the global markets came in March, when the U.S. administration announced tariffs on key trade partners. The objective of these tariffs is to reduce the trade deficit. Many economists and market participants worry about the friction that tariffs cause in global trade and the hindrance to economic growth from an all-out trade war. Encouragingly, over the course of the year, the U.S. administration achieved breakthroughs and reached a revised trade agreement with Mexico and Canada, two of its largest trading partners. Last week’s market declines came as concerns surfaced over the ability of the U.S. and China to reach an agreement during a 90-day trade truce that was determined at the G-20 summit. During this 90-day period, both parties have agreed not to impose additional tariffs and will work toward negotiating an agreement on trade.

The Fed and Yield Curve Inversion

Another fear that has been plaguing the U.S. market is the possibility of a yield curve inversion. A yield curve inversion occurs when short-term bond yields are higher than long-term bond yields. Why is this considered a bad omen? Many investors often interpret an inversion as a sign that companies don’t have enough confidence in their long-term prospects to borrow money and invest in their future growth, which is a signal that the economy is going to slow down or contract.

A yield curve inversion can also happen if the Federal Reserve “overshoots” and raises rates too quickly (or by too much) to slow down the economy, while yields at the longer end of the curve don’t go up by as much.

The 2-year to 10-year Treasury yield curve has not inverted (even though it has flattened considerably); if it does invert, a recession is not a certainty. The Federal Reserve is watching all signals closely and has cautiously raised rates over the past few years. But recessions do happen as a normal part of economic cycles and, while we can’t say when the next one will occur, we do know the U.S. economy has always recovered from recessions and market returns can become positive even before a recession officially ends.

What About Bond Returns?

In a period of lackluster equity returns, most investors rely on the bond portion of their portfolio for stability. As the Fed has raised rates over the past few years, the short end of the yield curve has felt most of the impact; however, intermediate-term rates have risen over the past year, resulting in negative returns within intermediate bonds. Bond yields and prices move in opposite directions — i.e., as rates go up, prices go down. Despite the short-term pain experienced in bonds — as bond prices decline in a rising-rate environment — the silver lining is that you are reinvesting at higher rates so, going forward, the expected returns to fixed income should be higher.

2018 Through a Long-Term Lens

With 14 trading days left in 2018, it is difficult to say where the stock market will end the year. While we understand that concerns about slowing global growth can make some investors nervous about the future, many of these fears already may be priced into the current market prices. The evidence shows that most professional investors are unable to accurately forecast the right moment to make changes based on short-term events, which is why we take a long-term, strategic investment approach backed by research.

60% MSCI ACWI/40% Bloomberg Barclays U.S. Agg. Index6

Growth of $100,000 Invested

There are some calendar years when market returns are negative and this could be one of them. Over the past 30 years, the returns of the MSCI All-Country World Index (a globally diversified index of stocks) were negative in eight calendar years and positive in 22 calendar years. If you include a bond investment and look at a 60%/40% portfolio (i.e., 60% stocks and 40% bonds), the return was negative in seven years and positive in 23 years. The total return to the 60%/40% portfolio over this period was about 800% — in other words, if you invested $100,000 at the beginning of this 30-year period, the number would have grown to $899,000 at the end of it. It is also worth noting that the U.S. experienced three recessions over this time period. Our focus is on maintaining an investment strategy that best positions portfolios to succeed over the long term, which requires discipline and tuning out the short-term noise — as distracting as it can be.

Learn more about our investment philosophy.

Return data represent past performance and are not indicative of future results. Historical returns of indices do not reflect applicable transaction, management or other applicable fees, the incurrence of which would decrease historical performance results. Index information has been compiled by Wipfli Financial from sources Wipfli Financial deems reliable, but has not been independently audited or verified. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only. Indices are unmanaged and unavailable for direct investment. Any charts and graphs represented herein are for informational purposes only and cannot in and of themselves be used to determine which securities to purchase or sell, or when to purchase or sell securities.

Reflecting on Recent Market Volatility Why Discipline Is Still Your Best Defense

Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC); however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services, fees and conflicts of interest is set forth in Wipfli Financial’s current Form ADV Part 2A brochure and Form CRS, copies of which are available from Wipfli Financial upon request at no cost or at Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Rafia Hasan

CFA, CFP® | Principal, Chief Investment Officer

Rafia Hasan, CFA, CFP®, is the Principal and Chief Investment Officer for Wipfli Financial Advisors, based in Chicago, IL. Rafia leads Wipfli Financial's Investment Committee and has a deep knowledge of the financial markets, specifically in the areas of alternative investments and private equity. She also specializes in personal financial planning and estate planning for women investors.

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Reflecting on Recent Market Volatility: Why Discipline Is Still Your Best Defense

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