1Q 2019 Market Commentary

by | Apr 15, 2019 | Market Commentary

It is wild how fast the market sentiment can shift. At the end of 2018 pundits were worried about a correction of 40-50%. It stopped at 20%. Now some are forecasting as much as 25% gains for 2019. Either way, in three months the mood went from despondent to enthusiastic.

Why the quick shift? Well, we live in a connected, a multi-faceted world, where most outcomes have a litany of root causes. Our best hypothesis is that we experienced a strong rebalancing effect in the fourth quarter. By that, we mean, as the trillions of dollars under the care of professional financial advisers were rebalanced in December to avoid taxes on capital gains, a sell-off ensued. Most investors waited thirty days plus one to avoid violating wash sales (i.e. making sure the losses count) and then shares were bought back in January. Hence, the bounce. We’re nearly back to all-time highs and global central banks are indicating further stimulus through year-end 2019.

The most recent economic data does look soft, GDP for the fourth quarter was revised down to 2.2% from 2.6%, pending home sales look weaker, and consumer confidence also weakened in March. Usually, the stock market is a leading indicator, the mass intelligence of all the participants tends to get the direction right but the magnitude wrong. Slowing does not mean stopping. Compounding at 2.2% real GDP on a $20 trillion-dollar economy is incredibly powerful. It’s a force to be optimistic about.

Most of us have a long-term horizon for some of our assets. A long-term horizon requires patience. Yet, the market can test that patience from time to time. Patience pays.

Above is an illustration of drawdowns experienced by investors with varying asset allocations. In the last 40 years, beginning 1979 and ending 2018, an all-stock investor would have experienced a -53% peak-to-trough return during the Great Financial Crisis. A more conservative 60% stock, 40% bond investor would have experienced a -32% peak-to-trough return during the Great Financial Crisis.

Here are the summary statistics by asset allocation and by decade[1]. Forty years of history is illustrative; however, it is no guarantee of future performance or guarantee the future will look like the past.

Modern financial theory teaches us that the holy grail is achieving the return of the red line but with the risk (“volatility”) of the orange line. To do this you must win by not losing. Cheeky. An investor must protect on the downside, while capturing most of the upside, to earn superior risk adjusted returns. The concept is simple but implementation is not easy.

A fund most clients own in their portfolio is the Akre Focus Fund. Akre is trying to capture the slippery and ever-elusive outperformance by focusing on capital protection as much as upside potential. By investing in good management teams, operating competitively advantaged businesses that are capable of reinvesting cash flows, they hope to grow capital at above average rates while taking on below average risk. They call it the “three-legged stool”. They aim to own concentrated, high conviction positions when prices are cheap and the ratio of expected returns to the risks is favorable. It has seemed to have worked.

Over the last five years, they have out earned their benchmark while taking on less risk, capturing 111% of the upside and only 86% of the downside[2]. Managers like Akre are rare and there is no guarantee they will continue their streak of above average return and below average risk.

Clients are best served by owning the portfolio they can stick with during good and bad times. And while the good times outweigh the bad, the bad can scare you out of the market. (It’s why the market slopes up and to the right) So, it is incredibly important to collaborate with us to identify your risk tolerances and build a suitable portfolio. It’s only through the constant exposure to risk assets over long periods of time that compounded returns accrue to the investor. Clients will experience satisfactory returns if they stick with a strategy designed to meet a long-term objective.

Here’s to continued growth and prosperity,

The Wright Associates Team 

[1] Index returns are monthly total returns. Past performance does not predict future performance. Hypothetical. You cannot invest directly in an index. Source: DFA Returns Web.

[2] Morningstar


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