*This report is available in video format on your Orion portal.*
The latest three month returns in the U.S. and international stock markets can be viewed with two very different attitudes. The first is that many indices (though not all) produced a loss for the quarter, and where there were gains, they tended to be very small. On the other hand, the losses, where they occurred, were too small to wipe out the gains of the previous two quarters, meaning that most investors have still made money so far this year.
Whether that will continue is anyone’s guess, but in today’s uncertain political and economic environment, it’s easy to feel like we all managed to dodge a bullet and are holding onto our gains with gratitude.
The third quarter saw small gains in the broadest market indices. The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—rose 1.23% in the most recent three months, and now stands at a 20.11% gain for the year. The comparable Russell 3000 index is up 20.09% so far this year.
International investors are still hanging onto gains after a difficult quarter. The broad-based EAFE index of companies in developed foreign economies lost 1.71% in the third quarter, but remains up 9.85% so far this year. In aggregate, European stocks are up 10.66% in 2019, while EAFE’s Far East Index has so far gained 7.53%. Emerging market stocks of less developed countries, as represented by the EAFE EM index, lost 5.11% in dollar terms in the third quarter, but the index is still up 3.65% for the year.
Our global equity fund, DFA Selectively Hedged Global Equity (DSHGX) is up 11.38% for the year and down 3.10% for the quarter.
Looking over the diversifying investment categories, real estate, as measured by the Wilshire U.S. REIT index, posted a 7.88% gain during the year’s third quarter, and now stands at a nice 27.21% gain for the first nine months of the year. Our global REIT fund (not an apples to apples comparison to the US index), DFA Global Real Estate (DFGEX) finished the quarter up 5.08%, leaving it up 22.10% for the year.
The S&P GSCI index, which measures commodities returns, lost 4.18% in the third quarter, but is still up 8.61% for the 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 3.07%, and is up 2.03% 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 0.17%, and up 4.17% so far this year. 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 down 1.54%, and is down 6.76% for the year. Rounding out the mix of equity-like funds, Steben Managed Futures Strategy (SKLIX), had a quarterly gain of 7.02% and is up 9.59% 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.
Many people thought bond rates had reached rock bottom last quarter, and that the inversion of yields could not continue, but they were wrong on both counts. Coupon rates on 10-year Treasury bonds have fallen to 1.69%, while 6-month bonds are now yielding a higher (but still meagre) 1.78%. Five-year municipal bonds are yielding, on average, 1.28%, down from 1.34% last quarter, while 30-year muni yields have fallen to 2.11% on average.
Our high quality bond funds, DFA Selectively Hedged Fixed Income (DFSHX), closed the quarter up 0.88% and is up 4.27% for the year. DFA Global Core Plus Fixed Income (DGCFX) was up 3.78% and is up 12.33% for the year. Our Treasury Inflation Protected (TIPs) fund, DFA Inflation Protected Securities (DIPSX) was up 2.51%, up a total of 9.22% for the year, while our high yield bond fund, Principal High Yield (PHYTX), finished up 1.30% and is up 11.18% on the year.
Where will the markets go from here? Of course, nobody knows with any certainty, but that doesn’t stop us from reading the tea leaves. There appears to be great uncertainty among investors about the Trump impeachment hearings, China trade tensions, drone strikes in Saudi Arabia and a messy “Brexit” across the pond. U.S. economic growth has cooled to a 2% annualized rate, and we are experiencing the first contraction in manufacturing in three and a half years. Exports have also been weak—a casualty of the China trade war.
At the same time, we are also experiencing the strongest labor market in several decades, with the pace of layoffs and the unemployment rate near a 50-year low. And consumer spending has been extremely strong, rising an estimated 4.6% year over year. Adjusted pretax corporate profits were up 3.8% in the third quarter (the most recent period for which we have statistics). Economists are hardly in consensus, but many predict that the economy will continue growing to the end of the year at least.
There must have been many times when the soothsayers in China looked at the tea leaves and didn’t see a clear pattern—though it is uncertain whether they then made up a plausible story for the Emperor. We aren’t inclined to try to make up a story here; the future of the markets is uncertain at the moment, with no reason to panic, and no reason to be surprised if a bear market were to start tomorrow. History has shown that bull markets tend to be longer and steeper than bear markets, which means that holding on tight in choppy times tends to be the winning strategy.