August 2024 Market Update - What in the World Happened
August Market Update (edited video transcript)
Hello, this is Josh Wolberg with Great River Financial, and this is your midyear update or what we like to call "What in the World Happened".
Quarterly Market Summary
In the second quarter US Stocks and Emerging Market Stocks did well, while US and non- US Bonds were basically flat, and Advanced Economy Stocks and Global Real Estate being down for the quarter. Since the end of the second quarter, Global Real Estate has seen a big bounce back with the expectations that interest rates are coming down - because they're quite interest rate sensitive and they're up almost 9% from July 1st through mid-August.
Long-Term Market Summary
When we zoom out a little further and look at 5 to 10 year numbers, US Stocks have outperformed their long-term averages of 9 - 10%, whereas, International Stocks in Global Real Estate have underperformed their long-term averages and Bonds have been, basically, flat during that 5 -10 year period - again, below their long-term averages. Now, we expect this to change at some point where overperforming assets will eventually underperform at some point, not necessarily negative, and underperforming assets will do at least their long-term average at some point in the future possibly a bit better.
Buying Low vs High
One of the most important inputs when we're thinking about investment returns are what do we pay for a particular investment. So, we can buy a good investment at too high of a price and have below average returns or a mediocre investment at a really low price and have above average returns. When we look at major asset classes around the world, you'll notice what this graph shows is zero is, basically, right on its long-term average price relative to earnings for stocks or relative to interest rates for bonds. Prices above zero are, basically, above their long-term averages and, basically, everything in US Stocks are above their long-term average price. When we look at things that are below their long-term average price US Bonds, as well as International Stocks, both in advanced economies and emerging economies, are below their average price. Now that doesn't mean they will outperform in the future, but it does mean they are on sale relative to past, where US Stocks are above their long-term average prices.
Vanguard’s Outlook for the Next 10 Years
We aren't the only ones keeping track of the current economic environment and concluding that the next 10 years won't look like the last 10 years. In fact, Vanguard is one of the largest investment managers in the world and their projection for the next 10 years for average returns is that US Stocks will return somewhere between 3 - 5%, on average, US bonds will be somewhere between 4 - 5%, on average, and International Stocks somewhere between 6 - 9%, on average over the next 10 years.
Diversification and Uncertain Markets
Based on our forecast and Vanguard's forecast it can be tempting to want to move more of our investments from areas we think are going to underperform to areas we think are going to outperform. This chart allows us to illustrate the benefits of long-term diversification and a disciplined rebalancing strategy. What it shows are asset class performance in each individual year rated from the best performing to the worst performing in each individual year and it contrasting with a diversified portfolio that's annually rebalanced, kind of in the middle every year. To illustrate the point, if we look at just Real Estate Investment Trust (REIT) since 2018 it's been one of the best performing asset classes in 2018 and 2019 then it went to the worst in 2020, the best in 2021, the worst in 2022, and kind of around the middle in 2023 and 2024. Now with the diversified portfolio in annual rebalancing, or disciplined rebalancing, what's going to happen in this case is when Real Estate Investment Trusts are really high we're going to sell it at a gain and buy things that are low in that year, and vice versa, when it's really low we're going to buy what's low and sell what's high over time.
The Index is One of the Best Managers
In addition to having a well diversified overall portfolio it's important to think about how we invest in each of these individual asset classes because it can make a big difference on the overall portfolio performance. So, what this shows is the 20-year return of a top decile manager versus a bottom decile manager and if you put $1,000 in a top decile manager in US Large Cap Stocks over the last 20 years it would have grown to about $7,500. In a bottom decile manager it would have grown to only $5,100 and that's a pretty big difference percentage wise. This is true of most asset classes in the US and around the world. If we had just bought an index, a large cap index, you would have gotten over $7,000, and that's true of most asset classes around the world, as well. If you buy an index you're in the top 15% over 10 plus year periods. Think of it like building a basketball team - we need to make sure we have players at every position, but if we could increase the probability that we had a top 15% player at every position we'd have a very good basketball team. So, building a portfolio, not just the overall, making sure we have all our bases covered, but also each of the bases is at average or above average is very important as well.
When Will Interest Rates Decrease?
One of the things we're monitoring closely is economic growth and interest rates. Now as economic growth has started to slow down a little bit, still positive but not as positive as it's been the last couple of years, the unemployment rate has started to tick up a little bit and inflation has continued to come down. It looks like the Federal Reserve is going to lower interest rates. That has multiple implications for the economy, but especially for investment markets. As interest rates go down, they tend to go down as quickly as they've gone up, so it might be a pretty rapid decrease in interest rates once they get started. Interest rates as they decrease are good for Bond markets, they tend to be good for stocks, overall, long term - maybe not in the short term because if the interest rate lowering is because there's a recession that's not necessarily good for stocks in the short term, but lower interest rates are good for stocks in the long term. It's good for long-term economic growth to have lower interest rates – it makes houses, cars, all those types of things easier to buy, so interest rates going down we see as a good thing over the next 3 - 5 years, if they start going down soon.
What About the Election?
A question I expect to get a lot between now and November is “how might the results of the election affect the economy and investment markets going forward?”. I expect there to be economic stimulus regardless of who wins in November. As economic growth has started to slow down, I expect interest rates to come down; that's going to be stimulative - that's not going to be affected by who wins the next election. Over the last 24 years we've switched between the two parties in the White House, Congress and the Senate multiple times and under all those different arrangements we've had either lower taxes, or extended tax cuts from the previous regime, and we've had higher and higher spending. Both of those things are stimulative to the economy, and thus, investments, at least in the short to intermediate term. Eventually, as a nation we're going to have to deal with the debt we've accumulated over the last multiple decades, but one thing we to keep in mind as investors is not to overreact based on our own political affiliation with what happens in Washington. If you look over the last 24 years, it's consistent that whoever is in the White House the voters for that party tend to be more optimistic about the economy. It happened under Bush, it happened under Obama, it happened under Trump, and it happened under Biden. What's key for us as investors, and including me as a financial advisor, is to keep a calm and level head and not overreact to who wins in November, because the economy is likely to grow, regardless, and the profits of companies are likely to be higher 10 years from now, regardless of who wins in November and that's what really drives investment markets going forward.
Next Steps
For next steps, if you have any questions give us a call, schedule a time on our website or shoot us an email. We're going to continue to look for opportunities to rebalance portfolios, where appropriate. If you found this helpful feel free to share it with somebody, like on YouTube, or subscribe on YouTube, as well. Thanks for watching. This is Josh Wolberg with Great River Financial - stay curious my friends.
