Monthly Outlook: February 2018
We’re off to a strong start in 2018! In fact, it’s been one of the best Januarys for stocks in the past 20 years. Stocks are on a persistent more-of-the-same run these past few years. Bonds are a different story, however.
U.S. stocks (S&P500) gained +5.5% in January, led primarily by the “FANG” stocks: Facebook, Amazon, Netflix, and Google. International stocks (FTSE All-world ex-USA) did just as well, gaining +5.7%, with emerging markets outperforming. Clearly, stocks continue to pump higher and the long-term uptrends remain intact. Bonds (Barclays Aggregate Bond Index), on the other hand, slumped in January due to the rise in interest rates. The U.S. 10-year treasury rate rose from 2.40% to 2.72% in January. That 1/3rd % rate rise doesn’t seem like much, but it’s enough for bonds (Barclays Aggregate Bond Index) to lose 1.24%, total return including interest. This slump in bonds is a new development that we’ll talk about later. Putting it all together, the benchmark for a 75/25 stock/bond portfolio was +3.3%, for a solid monthly gain.
Stocks tend to steal the limelight because they are volatile and exciting. They provide the bulk of growth (or loss!) to most portfolios. Meanwhile, bonds get dismissed as boring and steady plodders. But that’s really not fair to bonds. The bond market is actually quite diverse and includes bonds that are short to long term, investment grade to junk grade, U.S and international, government and corporate, and so on. All bonds are essentially loans where the borrower promises to pay back the loan, usually with interest, at some future date. As a result, there is one mathematical fact that affects all bonds: rising interest rates push bond prices down. Conversely, falling interest rates push bond prices up. Interest rates and prices move in opposite directions – always, always. And the longer term the bond is, the more the price moves.
While there are countless interest rates, most people key on a just a few rates for conversation purposes. These include the overnight “Fed Funds” rate that banks use to lend to each other, and the 2-year, 10-year, and 30-year U.S. treasury rate. The 10-year U.S. treasury rate has been zig-zagging lower for 30-years. It peaked at about 15% in 1981 and bottomed in 2012 at about 1.4%. It has traded in a 1.4% to 3.0% range for the past five years. The reason we’re on “bond watch” is that the rate has been creeping higher and is back to 2.7% today. And what did we just learn? Rising rates means falling bond prices. As money managers, we have already shifted portfolios into shorter-term bonds as a defensive move. Shorter-term bonds will still provide the stability and income that we need. We’ll continue to watch rates and will adjust as needed.
Stocks Still Enjoy FOMO
Enough talk about bonds. They’re just not glamorous, are they? Stocks continue to trend higher in spite of sky-high valuations. Investors are ignoring valuations and risk, and just keep buying stocks with fervor. The fear of missing out (FOMO) is palpable. And, as long as prices trend higher, the no-risk loop continues. We, too, remain fully invested stocks but with a very watchful eye. So far, in spite of myriad reasons, there has been no catalyst to change the collective psyche of stock investors and no “risk-off” selling. Anyone that has already sold stocks guessing that a correction would come is kicking themselves for the significant gains that they’ve missed over the past year or two. And, as we pointed out in the opening paragraph, the gains just continue in January. The summary takeaway on stocks is this: We’re very aware of the over-valuation and potential risk in stocks, yet we are staying invested for growth as long as uptrends are in place. We’re looking at every stock holding, every day, and stand ready to sell when/if the trend changes to down. Not yet.
The time to prepare is before the event. We appreciate the recent introductions that we’re receiving from you, our investors and advisors. We can help your friends continue to grow for now, yet stand ready to move to protection mode whenever it becomes necessary.