2019 Q1 Market Review: IFCMary Brunson and Murray Coleman
Wednesday, April 17, 2019
In the opening three months of 2019, U.S. and international equity indexes produced a dramatic about-face. Across every major asset-class and style benchmark reviewed by IFC, market conditions created a perfect storm to whipsaw short-minded traders.
The blue-chip S&P 500 returned 13.65% in the first quarter, reversing course from 2018's fourth quarter loss of 13.53%. Meanwhile, foreign developed stocks as measured by the MSCI EAFE index lost 12.54% in last year's final quarter, while in Q1 2019 that benchmark gained 9.98%. For emerging markets, the swing was -7.46% in Q4 to 9.92% in Q1.
The Q1 turnaround shouldn't come as a shock to seasoned long-term investors. But it may have caught short-term speculators by surprise ... again.
Those who understand how markets work know that greater volatility is key to capturing greater expected returns. Nobel Prize-winning research from William Sharpe and his Capital Asset Pricing Model bear out that risk and return are inseparable.
Unfortunately, those who bailed on their long-term investment strategy in Q4 impaired their abilities to reap Q1's rewards. History and pundits alike continue to discourage such reactive behavior. Investing sage Warren Buffett offers simple advice for managing market downturns. He has suggested that "as long as you are invested appropriately for your goals, stay away from your investment portfolio."
This begs the question: Why do people sell in down markets? There are many nuanced answers, but generally two major factors stand out. One is emotion. The other is a failure to understand that each day willing buyers and willing sellers go to markets to agree upon the best estimates of fair prices, incorporating all information that is either known or knowable. Following such an "Efficient Market" theory (courtesy of Nobel Prize-winner Eugene Fama), the inevitable catalyst that moves prices up or down is the news, which we do not and cannot know.
This fundamental truth is why those who attempt to time markets are ultimately doomed to underperform those same markets. The proverbial salt in the wound is the increased costs market timers incur, further eroding returns. There's a good reason why John Bogle quipped: "Don't just do something, sit there."
Easy to say, not so easy to do. What would make it easier? A little bit of knowledge can go a long way in helping investors stay the course. An investor needs to look only to the Great Recession of 2008-2009 to understand the importance of staying put during market turmoil. IFC's all-stock Index Portfolio 100 plummeted 50.25% during the one-year period from March 2008 through February 2009.
That wasn't a moment for the faint of heart. Ultimately, it was perhaps most trying for those who capitulated. The swift and intense reversal which ensued in the next 12 months produced a 70.77% return, erasing many of those losses and cementing the fact that volatility swings both ways.
What's the lesson here? Understand the market. Also, invest in accordance with your time horizon and your risk capacity. Then, hang on for dear life.
Now let's dig into the data for 2019's opening quarter.
The plight of U.S. stocks in Q1 serve as a prime example of how quickly market conditions change. After a volatile end to 2018, all of the IFA domestic stock indexes strongly rebounded to start the new year. The returns in Q1 were indeed impressive, ranging from 19.53% for IFA's U.S. small-cap growth equities benchmark to 10.79% with its sister large-cap value index. As further evidence that investors need to take a step back before considering making any portfolio moves, IFA's domestic large-cap growth equities index produced a 16.90% return and IFA's small-cap blended index rose by 12.42% — after suffering double-digit declines in Q4 2018.
International (Developed) Equities
IFA index returns from developed countries that are outside the United States all rebounded in Q1 from a sharp drop in the previous quarter. In Q1, results ranged from a gain of 9.92% for blended small-cap international equities to a rise of 8.46% for international large-cap value stocks. That was quite a change-in-course sequentially. In Q4 2018, international small-cap value fell by 17.91% and international blended value stocks did just slightly worse, losing 14.63%.
Emerging Markets Equities
Emerging Markets also had a very strong opening quarter of 2019. For Q1, emerging markets returns ranged from a gain of 8.80% for emerging markets blended small-cap equities to a rise of 7.15% for emerging markets large-cap value equities. By comparison, Q4 2018 returns ranged from -7.17% (emerging markets large-cap value equities) to -5.70% (emerging markets blended small-cap equities).
Real Estate Equities
Global real estate was another shining example in Q1 of the broad benefits in taking a diversified approach to investing. In the quarter, IFA's Global REIT Index returned 15.20%.
In the first quarter, the 30-year U.S. Treasury rate decreased by 16 basis points while the five-year U.S. Treasury rate decreased by 26 basis points.
For Q1, the four bond funds used by IFA delivered returns ranging from 1.71% for the IFA Five-Year Global Fixed-Income Index to 0.77% for the IFA One-Year Short-Term Fixed-Income Index. If interest rates have risen, the price of existing bonds with a lower coupon rate decrease so that new buyers of the bonds can get the same total return (capital gains plus interest) as that available from newly issued bonds at the higher rate and at similar risk.
IFC Index Portfolios
The returns of the IFC Index Portfolios are shown below net of the maximum annual 0.90% advisory fee through March. 31, 2019. Reflecting strong performances across indexes in both equity and fixed-income categories, each produced a robust rebound in Q1.
What investors need to keep in mind is that there will always be short periods in which their IFC Index Portfolios will have negative returns. How long those periods have lasted was directly tied to the amount of risk in the portfolio. This is the very nature of risk and the reason investors earn a return.
Given the recent underperformance in U.S. value stocks as compared to growth stocks in both large and small companies, some IFC clients may be wary about the subtle tilt toward small and value companies. The chart below shows monthly rolling period returns of the IFA U.S. Small Cap Value Index versus the IFA U.S. Large Cap Growth Index for the last 50 years. Over monthly periods, it has been a toss up between Large Cap Growth and Small Cap Value. But once we expand our view to longer time horizons, you can see that small value was the better index to own.
Each quarter, IFA monitors the funds they recommend for clients and as part of that process, we’ve developed a rating system. Below is a link to our Performance Monitoring Report for client portfolios: IFA First Quarter 2019 IFA Client Performance Monitoring Report.
We've created the Investing Kit that includes a copy of "Index Funds: The 12-Step Recovery Program for Active Investors" book and documentary film based on the book, as well as the Galton Board, Stock Market Edition, which simulates the distribution of 600 monthly returns right before your very eyes. You can find the Investing Kit on Amazon.