State of the Markets
The first quarter of 2019 saw a significant rebound from the very steep decline investors experienced in the fourth quarter of 2018. While the fears that drove last year’s declines have not fully dissipated, the probabilities of worst-case scenarios have certainly diminished. Investors have accepted the reality that economies around the world are doing fine, the U.S. Federal Reserve is not our enemy, and disruption of the government does not necessarily mean disruption of the economy.
All growth assets are thriving. The U.S. stock market (Russell 3000) is up 14% through the end of the first quarter. International developed markets (MSCI World ex USA) have returned 10.5% for the quarter, emerging markets (MSCI Emerging Markets) are up 9.9%, and global real estate (S&P Global REIT) is up 14.1%.
The bond market has adjusted to the reality that the Federal Reserve is not likely to raise rates as fast as previously expected, yields have gone down, and the return for the U.S. bond market (Bloomberg Barclays U.S. Aggregate Bond Index) is 2.9% for the quarter.
The total returns for major asset classes are below.
A Man and His Dog
Imagine a man walking his dog through a park. The man walks in a straight line from one end of the park to the other. He may vary a bit, but his path is pretty straight and steady. His dog, however, is on a more impetuous journey – sometimes in front, sometimes behind, tugging on the leash, stopping to sniff, and let’s hope she sees no squirrels. Think of the man as the economy and the dog as the markets. The stock market ultimately follows the path of corporate earnings, and corporate earnings ultimately follow the path of the economy, and while the economy is fairly steady, the stock market is path of the economy, and while the economy is fairly steady, the stock market is not [i]
The graph above, using data from the St. Louis Federal Reserve from 1971-2017, illustrates the trajectory and correlation between the economy, corporate earnings, and the stock market.[ii] Gross Domestic Product (in blue) is very smooth and steady. Corporate earnings (in red) show more variance from year to year but are certainly on the same trajectory. The stock market (Wilshire 5000 TR in green) is like a dog on a leash. It’s reactive to things that may happen as well as things that do happen.
Over 47 years, the Wilshire 5000 TR index, which is a proxy for the U.S. stock market (and the only index available in the St. Louis Fed database), suffered 28 significant market declines of 10% or more while the economy experienced only seven recessions. Despite these ups and downs, the index provided investors with an annualized return of 10.7%.
Here's the bottom line: short-term volatility is the price investors pay for higher long-term returns.
[i] Credit for this narrative goes to blogger and commentator, Josh Brown.
[ii] The chart is on a logarithmic scale. GDP is measured on the left axis. Corporate earnings are measured on the right axis. Wilshire 5000 is not measured on an axis but is shown on a logarithmic scale to illustrate the slope and trajectory of the stock market during the same period