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The long, painful market decline in the last month of 2018 seemed to promise more of the same for the new year of 2019, but at the end of the first quarter, the results couldn’t have been more different. The U.S. market, measured by a variety of indices, posted its biggest one-quarter gain since the third quarter of 2009. This proves once again (as has been proven many, many times over) that you cannot extrapolate market returns from one month to the next, or expect that down or up trends will lead to more of the same.
Just about every investment asset rebounded in the early months of 2019. The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—rose 14.23% in the 1st quarter.
International investors are experiencing somewhat smaller gains. The broad-based EAFE index of companies in developed foreign economies gained 9.04% in the first quarter. In aggregate, European stocks are up 9.42% so far this year, while EAFE’s Far East Index has gained 6.89%. Emerging market stocks of less developed countries, as represented by the EAFE EM index, gained 9.56% in dollar terms in the first quarter.
Our global equity fund, DFA Selectively Hedged Global Equity (DSHGX) accordingly finished up 11.31% for the quarter.
Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index, posted a 16.02% gain. Our global REIT fund (not an apples to apples comparison to the US index), DFA Global Real Estate (DFGEX) finished the quarter up 10.90%.
The S&P GSCI index, which measures commodities returns, gained a remarkable 15.97%. Our commodity fund, DFA Commodity Strategy (DCMSX), again not an apples to apples comparison as DFA isn’t as concentrated on oil as the index, significantly under-performed the index and finished the quarter up 6.91%.
In the equity-like portion of our model portfolios we saw Ironclad Managed Risk (IRONX), a strategy that sells put options on equity indices and exchange traded funds, was up 3.02%. AQR Style Premia Alternative Fund (QSPIX), a strategy that invests long and short across six different asset groups: stocks of major developed markets, country indices, bond futures, interest rate futures, currencies and commodities based on four investment styles: value, momentum, carry, and defensive, was up 1.11%. Rounding out the mix of equity-like funds, Steben Managed Futures Strategy (SKLIX), had a quarterly loss of -3.66%. We have these funds in our portfolio to produce returns that are not influenced by the equity markets, so in that regard they are performing as expected.
In the bond markets, we are experiencing a very slight inversion in the yield curve. Coupon rates on 10-year Treasury bonds have dropped to 2.41%, while 6-month bonds are now yielding a higher 2.42%, and 3-month bonds are yielding 2.38%.
Our high quality bond funds, DFA Selectively Hedged Fixed Income (DFSHX), closed the quarter up 0.96% and DFA Global Core Plus Fixed Income (DGCFX) was up 2.66%. Our Treasury Inflation Protected (TIPs) fund, DFA Inflation Protected Securities (DIPSX) was up 1.50%, while our high yield bond fund, Principal High Yield (PHYTX), finished up 6.11%.
These are, by any measure, extraordinary returns for a short three-month investment horizon, and nobody should expect that returns will continue at this pace for the full year. But the remarkable upsurge in stock prices does offer a lesson. Investors who took the December opportunity to buy stocks when they suddenly (and rather unexpectedly) went on sale are doubtless cheering their good fortune, but the larger number of investors who held on through December to reap the gains of 2019’s first quarter should be similarly cheerful. Selling into the downturn, hoping to avoid more losses, was a losing strategy.
It is also possible that the U.S. market is starting to get over its skis. Overall, American investors came out ahead of just about every developed or developing economy. The U.S. market performance finished only behind Ireland (up 30.5%), Greece (17.5%) and Italy (15.1%), well ahead of the U.K. (up 8.2%), Japan (5.3%) and India (5.3%).
Why are stock prices rising despite concerns about the yield curve inversion and persistent predictions of an upcoming recession? The answer could lie in some pleasant surprises that were contrary to what many investors were expecting. The Federal Reserve Board startled long-term market observers, in a good way, when it abandoned plans to continue hiking interest rates. Higher rates are considered impediments to higher market valuations for two reasons: they create more competition in the form of bond yields, and they raise borrowing costs for companies looking to expand.
Will the party continue? Who knows? The next few months will see many companies post their first quarter earnings per share, and negative growth (which is expected for many companies) could chill the surprisingly hot market. Nevertheless, slower profit growth is still growth, which suggests that a recession is not on the immediate horizon. Economists are still reluctant to predict an economic downturn when unemployment is at record lows, but it may be worrisome that the World Trade Organization’s leading indicator of global merchandise trade dropped to its lowest level in nine years. Many are watching the new round of U.S.-China trade negotiations, hoping for a breakthrough that would re-integrate disrupted corporate supply chains around the world.
It is worth remembering that some of the steepest rises in market indices come right before a bear market, when investors become over-enthusiastic despite declining fundamentals and high valuations. We do not seem to be in that territory yet, but nobody knows for sure. It’s always best to be cautious when the markets are rising fast, and optimistic when stocks go on sale. Actually doing these things is counter intuitive and very difficult emotionally, but for the intrepid, it has historically been a winning investment strategy.