What a difference a year makes.
At the end of 2017, we were in the midst of a period of unprecedented low volatility coupled with the S&P 500 Index returning almost 21% over the prior year. The Fed Funds rate was at 1.5% while the 10-year Treasury hovered just below 2.5%. Stock valuations were elevated as the markets were still processing the impact of the tax reform passed in the fourth quarter.
Fast forward twelve months: volatility has returned and the S&P 500 Index has declined over 16% in the fourth quarter of 2018, wiping out what had been modestly positive year-to-date returns. The Federal Reserve has stuck to its policy of normalizing interest rates and the Fed Funds rate is currently at 2.5% while the 10-year Treasury rests just below 2.75%. If all of this feels “out of the norm,” it’s because based on the past ten years, it is! The S&P 500 has not posted a negative calendar year return since 2008.
Further, geopolitical tensions have only added to the feelings of concern over the outlook for the global economy. Will the Fed’s rate increases prove to be too aggressive? Will there be material fallout from trade tensions between the world’s two largest economies (the US & China)? What will become of Brexit? These are just a few of the questions that we have been contemplating over the past several years in our thematic outlook and that we will take with us into the new year. Resolution and clarity will come in time, and presently we recognize the uncertainty this creates while also taking into consideration the fundamentals of the global economy in addition to those of the assets you own.
Valuations across the globe have returned to ranges that have historically presented reasonable entry points. The S&P 500 Index is trading at slightly above 19x trailing earnings and 15x forward earnings, which argues for being buyers and not sellers. Outside the US, valuations are even more attractive, arguably for good reason. Spreads in high yield credit have widened, indicating that the market is generally more cautious in its outlook for companies that offer below investment-grade credits. And, we have a flat yield curve with an expectation of the Fed hiking rates (albeit at a slower pace) in 2019.
What, if any, are the practical implications or actions to be taken? We would start by reaffirming our conviction in the philosophy of constructing diversified portfolios. This mix of investments, and the discipline to the strategy (in good times and in bad), is what allows our families to weather these periods of volatility and take advantage of dislocations through rebalancing. Additionally, as we alluded to earlier, we also blend tactical themes (one- to three-year time horizons) in concert with each family’s strategic portfolio targets. An example of this concept is evidenced in how we have constructed fixed income portfolios around more flexible managers that have been able to navigate rising rates effectively.
Information is derived from sources deemed reliable but not independently verified. This overview does not represent a specific investment recommendation and should not be construed as an offer to buy or sell securities.