The Markets And Economy Are Loosely Connected
As the stock market goes, so goes the economy. However, in any given year, economic ups and downs can diverge significantly from the direction of the market.
Just like walking your dog!
By SJS Founder & CEO Scott Savage.
Why is the stock market so volatile? What is today’s big drop telling us about the economy? What about yesterday’s big jump? Is there a recession coming? Another depression? Will I miss out on a market rebound?
We are experienced enough to know that we don’t know all the answers. But history has demonstrated that over long periods of time, the stock market and the economy are linked. As the stock market goes, so goes the economy. However, in any given year, economic ups and downs can diverge significantly from the direction of the market.
A well-traveled industry metaphor may be helpful in understanding the relationship between the day to day movement of the stock market and the real economy.
Imagine a dog owner steadily walking her dog through the park. The dog is on a leash but doing what dogs do in a busy park on a leash: barking, jumping, straining on the leash. To the left, then right, and then SQUIRREL!
The dog is the stock market, the dog owner is the economy. They end their walk in the park together, but along the way they sometimes move together, sometimes in opposite directions. If you simply watch the dog for a period of time, you might not know WHAT direction they are headed!
So the next time the market goes way up, or way down, we hope the dog owner and their “best friend” analogy will help you keep the long term view. That’s the view—and destination—we had in mind when your investment portfolio was designed in the first place.
Suggested Reading
Market Movements Q2 2020: The Sequel
In our estimation and experience, most predictions are largely speculative and unreliable. The only prediction we are prepared to make is based on historical evidence that prices/economies tend to recover after economic shocks.
By SJS President Kevin Kelly, CFA.
EQUITY MARKETS
Last quarter, global markets experienced a synchronous drop in equity asset classes. Investors around the world arrived at lower market valuations that included falling revenues and newly identified risks. We can now offer a more encouraging picture as a rising trend has been evident in the same asset classes during the second calendar quarter:
Source: Morningstar.com, July 1, 2020. Equity asset classes are considered representative by SJS Investment Services based on actual results of institutional mutual funds within these categories (DFQTX, DFIEX, DFCEX, and DFGEX). Actual performance for each client may be different. Past performance is no guarantee of future returns.
As of June 30, 2020, the quarterly gain in major equity asset classes spanned a positive range of 12 to 22%.
THOSE DOGGONE PREDICTIONS!
It is worth re-stating that in our estimation and experience, most predictions are largely speculative and unreliable. The only prediction we are prepared to make is based on historical evidence that prices/economies tend to recover after economic shocks.
But we acknowledge that things can get worse from here and the current upward trend is in no way guaranteed to continue. Predicting where the dog at the end of the leash will go is range-bound at best…and even then, the dog can sometimes break his leash!
Investments, by their nature, are unpredictable. Yet we continually strive to manage your investments so that you can have the confidence that your MarketPlus® portfolio has been trained at obedience school!
If you ever find the investment markets make you “uncomfortable,“ let us do the worrying for you, so you can focus on the people and causes that matter most to you. We are always here for you, to lend an ear, to listen, and assist!
Important Disclosure Information:
Past performance is no guarantee of future results. There is no guarantee investment strategies will be successful. Diversification neither assures a profit nor guarantees against a loss in a declining market. MarketPlus Investing® models consist of institutional quality mutual funds. Mutual fund investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with management of an actual portfolio. The performance of the indices was obtained from published sources believed to be reliable but which are not warranted as to accuracy or completeness.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
Value Opportunities
When you “buy low,” and prices go lower, it can test conviction. Nonetheless, we believe now is a good time to stick with and lean-in to MarketPlus Investing.
By SJS President Kevin Kelly, CFA.
Investor Howard Marks recently wrote, “All great investments begin in discomfort… ‘When the time comes to buy, you won’t want to.’ It’s not easy to buy when the news is terrible, prices are collapsing and it’s impossible to have an idea where the bottom lies. But doing so should be the investor’s greatest aspiration.”[1]
In an effort to buy low and sell high, many investors attempt market timing. However, studies have repeatedly shown that most investors who attempt to time the market significantly underperform broad market indices, due to many factors.[2] So if market timing is not reliable, what else can investors do to achieve higher expected returns?
MarketPlus Investing focuses on broad global diversification across thousands of securities via mutual funds. At the same time, we systematically seek stock attributes that have demonstrated higher expected returns over time.[3] Relative to broad market stock indices, MarketPlus Investing invests in mutual funds that tend to overweight stocks with financial qualities that, relative to their trading prices, have provided premium returns historically.[3,4]
Some of these qualities point us to smaller company stocks.[3] Other financial attributes suggest a bias towards “value stocks”, a quality that famed investor Warren Buffett tends to favor.[3,5]
In the spirit of Howard Marks, recent returns of small value stocks have provided plenty of discomfort, especially compared to the “blue chip“ index as represented by the S&P 500.
Sources: Ken French Data Library, Dimensional Fund Advisors Returns Web. As of 30-Apr-2020. See Important Disclosure Information for additional details.
But other than “discomfort,” are there any measurable indications that small value stocks may be a good place to invest? Perhaps one indication is that the valuation differences between US growth stocks and value stocks are at or near their greatest dispersions in history.[6] In particular, US growth stocks (particularly large growth stocks) are currently trading near valuations not seen since the 2000 Dot Com Bubble.[7] Contrarily, value stocks (particularly small value stocks) are below 40-year valuation averages, as demonstrated below.[8]
Sources: Dimensional Fund Advisors, CRSP, and Compustat. As of 31-Mar-2020. See Important Disclosure Information for additional details.
We do not believe these major valuation differences will continue over the long-term. Much of the recent outperformance of growth stocks is attributable to the performance of five of the largest stocks in the S&P 500: Microsoft (MSFT), Amazon (AMZN), Apple (AAPL), Alphabet (GOOG / GOOGL), and Facebook (FB).[9] These stocks currently make up > 20% of the S&P 500, and are all trading near all-time highs.[9] Based on forward price / earnings ratios, the stock market has already priced in high growth into these companies’ valuations.
Sources: Morningstar Direct, YCharts, Yahoo Finance. As of 29-May-2020. See Important Disclosure Information for additional details.
We think historically cheap investments are more likely to provide higher returns over time than expensive investments, and the data suggests small and value stocks are relatively quite cheap today.[10,11]
There are sometimes rare opportunities when specific parts of the market are very attractively valued relative to broad markets, which often leads to higher expected returns over time.[12] Is this such an opportunity? Only time will tell. But we believe broad diversification and a disciplined rebalancing mechanism that incorporates valuations helps investors get appropriate returns for the risk they are assuming.
When you “buy low,” and prices go lower still, it can be a test of investment conviction. Nonetheless, we believe right now is a good time to stick with and lean-in to our disciplined investment approach called MarketPlus Investing.
If you ever find the investment markets make you “uncomfortable,“ let us do the worrying for you, so you can focus on the people and causes that matter most to you. We are always here for you, to lend an ear, to listen, and assist!
Important Disclosure Information and Sources:
“Calibrating.“ Howard Marks, 06-Apr-2020, oaktreecapital.com.
Unconventional Success. David Swensen, 09-Aug-2005, Free Press.
“A Five-Factor Asset Pricing Model.“ Eugene Fama and Kenneth French, September 2014, Journal of Financial Economics.
“Dimensional Fund Advisors: A Deeper Look At The Performance.“ Mark Hebner and Murray Coleman, 04-Dec-2019, ifa.com. Please see Important Disclosure Information for additional information on MarketPlus Investing All Equity Model Portfolio.
“Berkshire Hathaway Inc. Shareholder Letters – 2020.“ Berkshire Hathaway, 2020, berkshirehathaway.com.
“Is (Systematic) Value Investing Dead?“ Cliff Asness, 08-May-2020, aqr.com.
“Lessons From the Dot-Com Bust.“ Mark Hulbert, 08-Mar-2020, Wall Street Journal.
“Spread the Word: What’s New with Valuation Ratios.“ Dimensional Fund Advisors, 14-May-2020, mydimensional.com.
“How Markets Work and the FAANG Mentality.“ Dimensional Fund Advisors, 2019, us.dimensional.com.
“Vanguard’s economic and market outlook for 2020: The new age of uncertainty.“ Vanguard Research, Dec-2019, vanguard.com.
“An Apology for Small-Cap Value.“ Verdad Capital, 04-May-2020, verdadcap.com.
“Crisis Investing: How to Maximize Returns During Market Panics.“ Daniel Rasmussen, Brian Chingono, Graham Infinger, Bryce McDonald, Greg Obenshain, and Chris Satterthwaite, 2019, verdadcap.com.
Past performance is no guarantee of future results. There is no guarantee investment strategies will be successful. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with management of an actual portfolio. The performance of the indices was obtained from published sources believed to be reliable but which are not warranted as to accuracy or completeness.
MarketPlus Investing® models consist of institutional quality mutual funds. Mutual fund investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
As of 29-May-2020, the MarketPlus All Equity Model is composed of the Dimensional US Core Equity II Fund (DFQTX: 54% weight), Dimensional International Core Equity Fund (DFIEX: 27% weight), Dimensional Emerging Markets Core Equity Fund (DFCEX: 9% weight), Vanguard US Real Estate Fund (VGSLX: 5% weight), Dimensional International Real Estate Fund (DFITX: 5% weight). There are limitations inherent in model allocations. In particular, model performance may not reflect the impact that economic and market factors may have had on the advisor’s decision making if the advisor were actually managing client money. Not to be construed as investment advice.
Advisory services are provided by SJS Investment Services, Inc.., a registered investment advisor with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide tax advice. Please consult your tax professional for specific advice. This material has been prepared for informational purposes only.
Statements contained in this report that are not statements of historical fact are intended to be and are forward looking statements. Forward looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
The S&P 500 Index is a free float-adjusted market-capitalization-weighted index of 500 of the largest publicly traded companies in the United States.
SJS Investment Services (SJS) has created hypothetical performance returns and financial information for the S&P 495 using actual historical performance and financial information of the S&P 500 and five constituent equities: Microsoft (Ticker MSFT), Apple (APPL), Amazon (AMZN), Alphabet (GOOG / GOOGL), and Facebook (FB). The S&P 495 is not an actual index created nor managed by Standard & Poor’s. The S&P 495 hypothetical historical returns do not reflect actual trading or the performance of actual accounts. Actual client results may be materially different than the hypothetical returns. All returns presented include reinvestment of dividends and other earnings.
Value (Fama/French US Value Research Index), Growth (Fama/French US Growth Research Index), Small Value (Fama/French US Small Value Research Index):
Composition: The index portfolios for July of year t to June t+1 include all NYSE, AMEX, and NASDAQ stocks for which we have market equity for December t-1 and June of t, and (positive) book-to-market equity data for fiscal year ending in t-1.
Exclusions: ADRs, Investment Companies, Tracking Stocks, non-US incorporated companies, Closed-end funds, Certificates, Shares of Beneficial Interests, and negative book values. Sources: CRSP databases for returns and market capitalization: 1926 -present Compustat and hand-collected book values: 1926- present CRSP links to Compustat and hand-collected links: 1926- present.
Breakpoints: “The size breakpoint is the market capitalization of the median NYSE firm, so the big and small categories contain the same number of eligible NYSE firms. The BtM breakpoints split the eligible NYSE firms with positive book equity into three categories: 30% of the eligible NYSE firms with positive BE are in Low (Growth), 40% are in Medium (Neutral), and 30% are in High (Value).”
Rebalancing: Annual (at the end of June) 1926-Present Fama/French and multifactor data provided by Fama/French.
Stocks are sorted on book-to-market ratio each June, where book-to-market for year t is computed using the book equity for the last fiscal year end in t-1, divided by market equity for December of t-1. Value and growth are stocks with book-to-market ratios above and below the 70th and 30th percentiles for NYSE stocks, respectively. Aggregate price-to-book value computed as the inverse of the weighted average book-to-market ratio where market equity is for the current month.
Small stocks are NYSE, AMEX, and NADSAQ stocks below the median market cap for NYSE stocks, and big stocks are above the NYSE median. Value portfolios include NYSE, AMEX, and NASDAQ stocks above the 70th percentile of the book-to-market equity ratio (B/M) for NYSE stocks. Small Value stocks are both small and value, Big Value stocks are big and value, and Market Value includes all value stocks. Market Growth includes NYSE, AMEX, and NASDAQ stocks below the 30th percentile of the book-to-market equity ratio (B/M) for NYSE stocks. Small is the portfolio of all small stocks with no value tilt. The portfolios are value-weight (VW) and are reconstructed at the end of June each year. For each return horizon, the table shows average premium (Ave), standard deviation of premiums (Std), skewness (Skew) and kurtosis (Kurt), the percent of negative premiums (Neg), and percentiles of the distribution of premiums. The Monthly row in each block summarizes the distribution of actual monthly returns. Each of the remaining rows summarizes the distribution of returns produced by 100,000 simulations of returns for a particular horizon. The simulations allow for uncertainty about expected premiums.