Expectations vs. Reality Market Wrap - First Quarter 2017

The market has been on a steady climb since the November 2016 elections. What’s been called the “Trump bump” has pushed stocks higher in anticipation of a friendlier business environment entailing lower taxes, less regulation, and new investment in infrastructure and equipment. But now, expectations are running up against the harsh wall of reality as the Trump Administration is tasked with turning campaign platforms into legislation and dealing with a difficult and divided Congress. Is the “Trump bump” at risk of turning into the “Trump slump” if expectations aren’t realized? Let's take a quick look at how the economy and markets fared in this first quarter of the year.

Speculation giving way to reality

Immediately after the election, the market took off in anticipation of what people thought the new Administration would do. Investors foresaw a scenario of rising infrastructure stocks and interest rates, robust economic growth in the U.S., and lower tax rates. Not surprisingly, reality is a little more nuanced. The end result is a solid first quarter of market performance, where a balanced portfolio of U.S. stocks and bonds would have returned a little over 3%. But future progress may be harder to achieve. U.S. stocks are now more expensive than they were a year ago. “We should always remember that higher valuations mean lower yields and lower future returns,” says Rob Arnott, well-known market strategist and founder of Research Associates. So does that mean it’s time to head for the hills, or sit on the sidelines? Not at all. But it does mean it’s time to use some investment common sense and prepare for a rockier ride ahead.

Buy more of what’s on sale The best performers going forward may be those with more modest valuations today, like international, emerging market or out-of-favor health care stocks. International stocks surprised everyone by staging a strong comeback in the first quarter. No one seems to be noticing, but global growth (outside the U.S.) is on the upswing.

Don’t bail on bonds As expected, the Federal Reserve hiked rates 0.25 (¼ of 1%) in December and March, with two to three additional hikes expected for 2017. That’s a healthy sign that the U.S. economy is returning to normal. In an environment of gently rising interest rates, bonds will not be exciting performers. But as we’ve been (correctly) saying for years, investors should continue to invest in bonds, according to their individual asset allocation plan, to ensure predictable income and lower portfolio risk.

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Continue saving enough for the future If you are neglecting to save and count on magical investment results to bail you out, think again. Smart investing over time can turn a small pile of money into a big pile. But nothing saved will still be nothing years later. (And leaving money in cash or super-conservative investments for years will also leave you with next to nothing). You need to save 15% of your income each year to stay on track in today’s world.

Be realistic with market expectations Retired Vanguard founder and investment pioneer Jack Bogle says stock market returns may be lower going forward than they have been in the past. We hope he’s wrong, but the point is that we need to make intelligent and measured portfolio decisions to capture the gains you need without assuming unnecessary risks. ❖

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Is A Correction Coming Our Way?

The stock market has enjoyed a pretty steady climb upwards since the November election. Could that calm soon be coming to an end? If so, it’s a good time to brush up on market corrections and how you can take volatile and hostile markets in stride.

First of all, what is a correction? A correction is our way of saying that stocks are experiencing a 10% pullback or price decline. For example, a 10% correction

from today’s prices would signal a drop from 20,400 on the Dow Jones Industrial Average to 18,360.

Will there be a correction soon? Based on nothing other than recent history, it’s fair to say there will be a 5% or 10% pullback soon. Since 1990, we have averaged a 5% decline (or “correction”) about 3 times per year on average. Declines of 10% or more happen about once per year on average. A 20% correction is less frequent (fortunately!), occurring every 3 1/2 years on average. So it’s fair to say that a correction is not a question of “if.” It’s a question of “when.”

But can’t we predict when it will happen? Researchers have studied market behavior over the last century. Their conclusion? “It’s easy to look back today and say with hindsight that the stock market was overvalued at a particular time and due for a decline. But no one has been able to accurately predict market declines on a consistent basis.” Successful market timing during a decline is extremely difficult because it requires a pair of near-perfect actions: getting out and then getting back in at the right time. We think there are better ways to control market risk – such as proper asset allocation, diversification, dollar cost averaging, and liability management – that don’t compromise your ability to capture the market’s long-term growth.

What should I do if and when prices do correct? In most cases, the right thing to do is “nothing.” If you are fully invested, stay that way. The worst thing you can do is sell when prices are lower, only to buy back when they go back up again. And don’t forget, pullbacks can often be valuable buying opportunities. The last correction was in early 2016, so we may be a bit overdue for a pullback. If prices do correct, don’t panic. Corrections often don’t “mean” anything. They just happen.

“Stock market corrections are an inevitable part of investing,” say researchers. By accepting the normal up-and-down risks of the stock market, you get a ticket to participate in the long-term gains that only the stock market has been able

to generate. ❖