How to make sense out of the recent market behavior? We experienced a painful decline in the last month of 2018 before the markets took a sharp (and unexpected) about-face and delivered the biggest one-quarter gain since the third quarter of 2009. The surprise upward trend has continued through the second quarter, albeit with more modest gains, despite what would normally be considered warning signs in the economy, the global trade markets and corporate earnings.
If we could simply stop the year at this point, the gains would be unusually high for a typical 12-month period; for six months, they are extraordinary. Perhaps we should celebrate cautiously.
Just about every investment asset produced gains in 2019’s second quarter. The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—rose 3.99% in the most recent three months, and now stands at an 18.66% gain for the year.
International investors are also sitting on gains. The broad-based EAFE index of companies in developed foreign economies gained 2.50% in the second quarter and is up 11.77% so far this year. In aggregate, European stocks are up 13.20% in 2019, while EAFE’s Far East Index has gained 7.80%. Emerging market stocks of less developed countries, as represented by the EAFE EM index, lost 0.31% in dollar terms in the second quarter, but the index is still up 9.22% for the year.
Our global equity fund, DFA Selectively Hedged Global Equity (DSHGX), is up 14.79% for the year.
Looking over the diversifying investment categories, real estate—as measured by the Wilshire U.S. REIT index—posted a 1.63% gain during the year’s second quarter, for a 17.92% gain for the first six months of the year. Our global REIT fund, DFA Global Real Estate (DFGEX), (not an apples-to-apples comparison to the US index) finished the quarter up 3.79%, leaving it up 17.30% for the year.
The S&P GSCI index, which measures commodities returns, lost 1.42% in the second quarter, but is still up 13.34% for the year. Energy prices are up 22.80% in 2019, while precious metals have gained 8.86% so far this year. 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 underperformed the index and finished the quarter down 4.29%, and is up 4.91% for the year.
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, down 1.21%, and up 4.35% so far this year. AQR Style Premia Alternative Fund (QSPIX) was down 4.61%, and is down 5.22% for the year. This fund is 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. Rounding out the mix of equity-like funds, Steben Managed Futures Strategy (SKLIX), had a quarterly gain of 4.16% and is up 2.55% on the year. 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.
The bond markets continue the long stretch of low-yield environment, coupled with either a flat or inverted yield curve, depending on where you look. Coupon rates on 10-year Treasury bonds have dropped to 2.01%, while 6-month bonds are now yielding a higher 2.09%.
Our high quality bond funds, DFA Selectively Hedged Fixed Income (DFSHX), closed the quarter up 1.80% and is up 3.41% for the year. DFA Global Core Plus Fixed Income (DGCFX) was up 3.73% and is up 8.71% for the year. Our Treasury Inflation Protected (TIPs) fund, DFA Inflation Protected Securities (DIPSX) was up 4.08%, up a total of 6.81% for the year, while our high yield bond fund, Principal High Yield (PHYTX), finished up 1.55% and is up 9.55% on the year.
What’s going on? It’s tempting to think that the bull market is running out of steam, in part due to the fact that it’s not easy to see how valuations can go much higher. The price-to-earnings ratio of the S&P 500 index—a popular way of valuing stocks—is 21.83 on a trailing basis, compared with a 10-year average of 17.87 and a long-term historical mean of 15.75. At the same time, a popular haven for retreat from the markets—gold—is also above its historical value; the precious metal is not far from its highest level in six years, at $1,413 an ounce.
Bonds are not attractive investments at the 2% range for Treasuries, especially when your yield on six-month issues is higher than if you take the risk of investing over ten years.
Moreover, there is growing uneasiness about a global slowdown in economic activity, and trade wars and the threat of trade wars are not likely to boost the global economy, even if the recently-announced detente between the U.S. and China holds. Sluggish profit and economic growth are not normally a recipe for higher stock prices.
You might imagine that a strong first half of the year would normally be followed by an easing back or even a drop in value over the second half, but that hasn’t necessarily been the case historically. In years in which the U.S. market rose in the first half of the year, the odds of a positive second half, based on the historical record, are 72%. That certainly doesn’t guarantee anything, but it does suggest that market movements tend to be much harder to predict than one might imagine.
All of us were surprised at the roaring start to 2019 considering the downturns at the end of 2018. We can expect to be surprised again, either on the upside or the downside, in the second half of this year.
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