The current economic expansion is now the second-longest U.S. economic expansion ever, surpassing the period of growth that occurred from 1961 through 1969. If the current expansion holds through the summer of 2019, it will earn the top spot in the history books, exceeding the 10-year span between 1991 and 2001, which currently holds the No. 1 position. For quite some time now, investors have been wondering when the current economic expansion might end, and what to do with their portfolios that may have highly appreciated equity values disproportionate to their asset allocation targets. Commerce Trust Director of Investment Research Barbara S. Turley, CFA, takes a look at the current environment and provides guidance for investors.
The current economic expansion, now almost nine years old, has become the second-longest economic expansion since 1900. Economic expansions don’t really die of old age, but economic stresses tend to grow over time as a recovery unfolds. In general, most expansions end as some unforeseen shock occurs while the Federal Reserve (Fed) is raising rates to combat late-cycle economic inﬂation. That inﬂation is typically sparked by a combination of rising wage growth, higher energy prices, and an overzealous credit expansion or asset bubble.
We believe this economic expansion will likely be our longest, and in the absence of external shocks, could last several more years. But that doesn’t mean we aren’t seeing early warning signs of its eventual end, some of that expressed in 2018’s market turbulence.
While the current expansion has coincided with robust equity markets and generally low volatility, the first quarter of 2018 ushered in a period of volatility that we have not witnessed for quite some time. We had entered the year with expectations for equity returns to be considerably lower than those we enjoyed in 2017, since stock valuations were and continue to be elevated relative to historical standards. However, the surge in volatility has been notable.
During periods of increased market volatility, many investors become nervous and begin to question their equity holdings. Equities have produced a 9.9% annual return since 1925, considerably higher than the long- term return of bonds. Stock market returns have been particularly high since the end of the 2008 financial crisis (more than 14% per year). It is normal for stocks to rise over the long term but to experience periodic corrections over short-term periods. In fact, there have been 23 equity corrections of 20% or more since 1926. For example, in the 2008 financial crisis, the S&P 500 Index was down about 51% from peak to trough. It took 3½ years to recover from that correction.
Our philosophy is that investors should invest for the long term (in accordance with their time horizon). We believe it is important to employ a long-term, or strategic, asset allocation that is appropriate for your risk tolerance and other circumstances and then stick to it. If you believe you are in the appropriate risk category for the long run, we believe you can confidently “stay the course” during periods of market stress. We do believe that it is important to periodically re-evaluate your portfolio’s long-term, strategic asset allocation to ensure it remains appropriate, but in the absence of changes to your life circumstances, you can have confidence that you can withstand market volatility. Remember that it is the nature of the markets to move up and down over the short term, and successfully timing the market is nearly impossible. In these normal up-and-down cycles, it is important to stay focused on your long-term portfolio goals. Having a well-thought-out portfolio strategy that can weather these changes helps investors sleep better at night.
Of course, when one asset class has dramatically outperformed or underperformed, we believe in rebalancing portfolios back to their target allocations. Rebalancing helps an investor maintain a desired risk profile through a natural process of “selling high” (selling out of asset classes that have performed well) and “buying low” (buying into asset classes that have performed poorly). In a typical portfolio of stocks and bonds, it might have been reasonable in decades past to allocate or rebalance surplus stock allocations into fixed income. But investors have been reluctant to pursue this course in recent years because bond yields continue to be below the norms of past decades due to the prolonged, relatively low rates set by the Fed. While bond funds have not performed well this year due to rising interest rates, we still believe they offer portfolio protection by smoothing out overall returns over the long haul.
If your life circumstances have changed and you are concerned about the possibility of a stock market correction, you may want to take this opportunity to “de-risk” your portfolio by reducing your equity exposure. Some investors find it difficult to assess their risk tolerance until a correction occurs. An asset allocation study can help you determine your risk profile. Once you determine the right asset allocation for your long-term needs, you can have confidence that you are on the right path despite market conditions. And keeping your portfolio well diversified can help smooth returns when only certain areas of the market are volatile.
Call Your Financial Advisor If You Feel Stress Over Your Portfolio
As mentioned in our message to clients during the market instability in February, investors should generally maintain their asset allocations in their portfolios and work with their advisors. We always encourage clients to contact their Commerce Trust Company advisors should they have any questions or concerns.
Focus on What You Can Control
World events, inﬂation and economic growth are just a few factors you cannot control, so worrying about them doesn’t help. You can, however, control how much you spend or save, as well as the diversification within your portfolio. Focus on factors within your control to help manage stress.
Limit the Noise
If you get unnerved by the market, tune out the media. Watching and listening to “chatter” can increase your discomfort.
Set a Strategy and Stick to It
Investing to achieve your financial goals is a marathon, not a sprint. Don’t get off course to chase an investment fad or decide to sit on the sidelines because markets shift. Once you have a disciplined investment strategy that supports your long-term financial goals, stick to it. To ensure your strategy still supports your goals, review it annually or as life events, such as retirement, occur. After all, your goals are the reason you are investing.
Empower Yourself Through Education
While you should refrain from making any major investment decisions if you are confused or feeling overwhelmed, the more you understand how investments work, the better you will be able to manage investment risk. Education is a great antidote to fear.
About the Author
Barbara oversees the quantitative and manager research functions of Commerce Trust Company. These groups provide research for asset allocation, manager selection, and performance measurement for institutional and private clients. Barbara was previously employed at Bank of America and its predecessor organizations, where she was most recently vice president and head of the healthcare equity research group. She has more than 20 years of experience in the investment industry in various capacities. Barbara has extensive experience teaching corporate finance and investments at University of Missouri. She also has been interviewed by various financial print and broadcast media. Barbara has a master in business administration degree from Washington University in St. Louis and holds the Chartered Financial Analyst® designation. She is a member of the CFA Institute and the CFA Society of St. Louis.
The 2018 investment commentary is a special report designed to provide investment information on economic markets for Commerce Brokerage clients. It is intended to provide general information only and reflects the opinions of Commerce Trust Company’s Investment Policy Committee.
Commerce Trust Company is a division of Commerce Bank. Commerce Brokerage Services, Inc., member FINRA and SIPC, and an SEC registered investment advisor, is a subsidiary of Commerce Bank.
This material is not a recommendation of any particular security, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional. The information in this commentary should not be construed as an individual recommendation of any kind. Strategies discussed here in a general manner may not be appropriate for everyone. Diversification does not guarantee a profit or protect against all risk. Past performance is no guarantee of future results, and the opinions and other information in the investment commentary are as of March 20, 2018.
Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product or specific financial situation. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. All expressions of opinion are subject to change without notice depending upon worldwide market, economic or political conditions.
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