A Quarter in Review: First Quarter 2019

Coming into the year, there were two big unknowns that scared investors – trade war and interest rates. Investors received more clarity on each in January and the markets staged an impressive rally. Trade tensions eased in January when early indications pointed to constructive dialogue and meaningful progress between the U.S. and China surrounding trade. This increased the probability of a trade agreement happening later this year. More importantly, investors received favorable news on interest rates when the Federal Reserve Chairman announced a plan to stop raising interest rates this year.


Fixed income had a good quarter. U.S. bonds returned 2.94% and global bonds earned 2.96%. The Federal Reserve has been raising interest rates since 2015, taking it from 0% to 2.5% today. Coming into the year, the Federal Reserve had plans to continue to tighten financial conditions. The plans quickly changed when slowing global growth, trade tensions, and the government shutdown caused capital markets to panic. The U.S. central bank recognized the volatility it was causing by tightening too quickly and decided to put a pause on plans to tighten. Central banks around the globe followed suit as the economic momentum has slowed across the globe. Lastly, the yield curve has garnered much attention in the press with certain parts of the yield curve inverting. Central banks have suppressed interest rates for many years now and have intentionally distorted yields. There is some debate now about how reliable the yield curve is given these circumstances.


Stocks around the globe bounced back aggressively after the sell off at the end of 2018. U.S. stocks led the way returning 14.04%, with international stocks not too far behind returning 10.45% and emerging markets earning 9.92%. Renewed hope surrounding trade negotiations between the U.S. and China and a shift in monetary policy from the Federal Reserve were the main drivers behind this current rally. The returns we have achieved so far are impressive, but we cannot expect this pace to be sustained for the rest of the year – some volatility is to be expected. We’d be remiss not to mention the milestone that occurred this quarter. The U.S. bull market reached 10 years in March, making it the longest bull market since World War II. The last 10 years have been a phenomenal ride with the S&P 500 returning over 300% during this period. A decade is a long time, but bull markets do not die of old age. They usually require a trigger event such as excess valuations, higher valuations, or recession, which we do not see at the moment.


The U.S. economy remains sound as we enter the 10th year of this economic expansion, but we recognize we are in the later stages of this cycle. Growth is decelerating but is not negative. We are expecting growth to fall from 3% to the 2% range as tax benefits wane. The labor market remains tight with unemployment rate at 3.9% and inflation contained. Based on the economic indicators we follow, the probability of a U.S.  recession in the near term is low. Globally, we are seeing a faster slowdown in growth as trade issues have impacted international markets disproportionately, but we don’t see a global recession now. Mario Draghi, the European Central Bank President, said, “lower confidence produced by trade discussions… this sort of diminished confidence filtering through countries and sectors is one major factor for the slowdown.” The European Central Bank is now taking the necessary steps to stabilize the economy by again easing their monetary policy to bolster the economy. Draghi sees the probability of a recession as “very low.” 


Déjà Vu All Over Again

Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities.

Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.” 


Looking back at some investment fads over recent decades can illustrate how often trendy investment themes come and go. In the early 1990s, attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan.
A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or trends have come into and fallen out of vogue. In the 1950s, the “Nifty Fifty” were all the rage. In the 1960s, “go-go” stocks and funds piqued investor interest. Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of information technology and telecommunication services. During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular. In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest-rate environment in the following years, other funds sprang up that claimed to offer increased income generation, and new strategies like unconstrained bond funds proliferated. More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered attention among investors.


Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world. 

With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.

It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured. 


When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:

1. What is this strategy claiming to provide that is not already in my portfolio?

2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?

3. Am I comfortable with the range of potential outcomes?

If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, a market portfolio offers the benefit of exposure to thousands of companies doing business around the world and broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio, investors should understand the potential benefits and risks of doing so. 

In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals. 


Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets. 

Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Diversification does not eliminate the risk of market loss. 

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. ©2019 Dimensional Fund Advisors LP. All rights reserved. Unauthorized copying, reproducing, duplicating, or transmitting of this material is prohibited.