The following is an excerpt from our Q3 2017 client newsletter...
The happy, dull reality is that the third quarter mostly continued the same themes from the first half of the year. Led by emerging markets most major asset classes posted gains, volatility was muted, and U.S. stocks established new record highs.
Emerging Market (EM) stocks have built on a strong 2016 with a thus far profitable 2017. The MSCI Emerging Markets Index is up 27.8% year-to-date and has outpaced developed markets (DM) since early 2016.
While the uptrend is still new (EM stocks were down in 2013, 2014, and 2015), encouraging stories have emerged:
· Broad Growth. All 24 EM countries* reported positive growth in Q2. EM countries depend less on trade than ever. This may signal a budding middle class and less reliance on rich countries.
· Stable Currencies. In the past, including 2013’s Taper Tantrum, when the U.S. Federal Reserve raised rates, EM currencies fell sharply, which negatively impacts U.S. investors’ EM stock returns. Since 2015, the Fed has raised rates four times, and EM currencies have stayed steady.
· Monetary Independence. EM central banks have successfully avoided raising rates to stay competitive with the Fed.
· Commodities. Commodities are one of the few poor performers in 2017. Last decade, commodities were about 30% of the EM stock index. Today, they are about 15%. Technology is now the largest EM sector.
This year’s most striking theme has been the steadiness of returns. Through nine months, the S&P 500’s largest decline has been a paltry 2.8% - from early March to mid-April. This would be the second lowest intra-calendar year pullback since 1929.
The march upwards has produced many new all-time market records. Upon reaching new heights, it’s natural to wonder whether we’ve reached a peak. Usually that concern is dwarfed by enthusiasm for more gains. However, today’s record-breaking market seems to generate as much worry as joy.
Investors with decade-old scars see a 2007 repeat around every corner. The financial media doesn’t help. The Great Recession taught commentators the potential power of bold predictions: if I’m right, investors will throw money at me and Hollywood might celebrate my quirky genius (The Big Short).
Yet, data shows that a market high is nothing remarkable. Since 1980, the S&P 500 has experienced 740 new records. There have been 174 since 2013 alone.
On occasion, a record will pivot to a steep decline (1987, 2000, 2007). However, relative to the frequency of highs, steep slides are rare. Selling stocks upon a new high is much likelier to mean foregone gain than foregone pain.
Even if an investor sells at the perfect time before a decline, he also has to bravely re-enter a depressed market. The investor has to outsmart the market - the consensus of the whole world’s wealth - not just once but twice.
Not market-timing is the better strategy. Pre-Great Recession, the S&P 500 peaked in October 2007 (see chart below). It then dropped nearly 58% until bottoming in March 2009. Four years passed before the market recovered its previous high water mark in April 2013.
Nonetheless, over the last decade the S&P has doubled in value, earning over 7% per year annualized. Despite being tested to the extent no investor had experienced in their lifetime, patience was rewarded.
This is all the more impressive considering the deep mathematical hole that the Great Recession dug. In order to just recover to even from a 58% decline, an investment needs to gain nearly 140%!
Rather than signify a red light, a market record means that investors should forge ahead; another high is likely around the corner. Remaining an investor amid concerns is a better approach than trying to time the market twice.