“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Charles Prince, Citigroup CEO. July 2007 interview with the Financial Times.
“History doesn’t repeat itself but it often rhymes.” Aphorism often attributed (probably incorrectly) to Mark Twain.
For investors in the U.S. stock market the music is playing and investors are dancing. While other asset classes have had sell-offs and corrections, the U.S. stock market just keeps on rolling. In the third quarter the S&P 500 was up 7.7%, bringing its year-to-date return to a robust 10.6%. This quarterly return was the largest quarterly gain for the S&P 500 since the fourth quarter of 2013. U.S. small cap stocks are not missing out on the party. The Russell 2000 was up 3.6% in the third quarter and is now up 11.5% for the year-to-date. Digging below the headline numbers, however, a different story begins to emerge. The Russell 1000 Growth Index, a commonly cited benchmark for large, growth-oriented companies, increased 16.3% through September, while the Russell 1000 Value Index, the benchmark for large value stocks, increased only 5.7%. This disparity with growth stocks, primarily technology and health care stocks, outperforming value stocks has been a hallmark of this bull market over the last several years. While the U.S. bull market has roared, it has been a much bleaker picture for foreign equity markets in 2018. The MSCI-EAFE Index is down 1.4% for the year in dollar terms. And emerging markets, represented by the MSCI-EM Index, have done even worse, down 7.7% thus far in 2018.
Fixed Income markets continued to muddle along in the third quarter. The Bloomberg Barclays U.S. Aggregate Bond Index, the most commonly used index for investment grade bonds in the U.S., gained a paltry 0.02% in the third quarter and has lost 1.6% for the year. The losses sustained by bond investors are due to the steady rise in interest rates throughout the year. The increase in interest rates has occurred across the yield curve. The 6-Month U.S. Treasury yield has moved from 1.53% at the end of 2017 to 2.19% at the end of the third quarter. Likewise, the 10-Year U.S. Treasury yield has increased from 2.40% to 3.05% and the 30-Year Treasury yield from 2.74% to 3.19%. This continued upward pressure on rates in the third quarter appeared to be due to several factors. First, the Federal Reserve raised rates for the third time this year and the market consensus seems to point to a fourth raise in rates near the end of the year. In addition, the economy continued to show signs of strength through rising wages, solid economic growth, and bullish consumers and investors. Finally, there was some thawing in trade negotiations, which resulted in a lessening of trade tensions with some of our largest trading partners.
Rising oil prices contributed to positive returns in the energy sector. West Texas Intermediate Crude Oil (WTI) has risen in price from $60.46 at the end of 2017 to $73.25 at the end of the third quarter. The 21.2% price increase is a result of a classical imbalance between supply and demand – constrained global supply due to sanctions on Iranian oil exports and production bottlenecks in the U.S., combined with rising global demand.
While some investors may be disappointed with the performance of a diversified portfolio, these investors may be inadvertently dancing to a tune that is closer to its end than its beginning. We can’t know for sure when markets will turn, or the exact manner in which a reversal will happen. But while we wait for the music to stop for U.S. stock markets, it seems prudent to utilize asset classes other than just U.S. stocks. This includes (almost) any asset class other than the S&P 500. Because sooner or later the music, and the dancing, will move on to a different venue.