Asset Class Returns — Weekly Observations for 7/13/2018

As promised two weeks ago, following is a recap of the returns for the primary investment asset classes year-to-date through the end of the second quarter, along with my assessment of the opportunities. Asset class returns listed are sourced from Blackrock and State Street Global.

Global stocks are down 0.43% (MSCI ACWI)

There are dozens of sub-categories of stocks we could evaluate, and the differences in returns between regions, sectors, and companies are dramatic this year. In aggregate, stocks are flat to slightly down year-to-date. While valuations are sky-high in certain sectors (many sectors, actually), I am beginning to find more and more pockets of value, which I’ve routinely discussed in these weekly notes.

On the whole, the risk exposure of stocks greatly outweighs the potential reward, so I am being very careful with our selection of investments in this asset class

Bonds are down 1.62% (Barclays US Aggregate)

During the last two years, interest rates as measured by 10-year US Treasury bonds have doubled from below 1.5% to over 3%. Today, rates stand at 2.83%. If you’re buying bonds (and we are), this rise in rates is great news. But a well-known feature of bond pricing is that as interest rates rise, the price of existing bonds falls. If you hold the bond until maturity, the price change is temporary but certainly visible in portfolio values in the interim.

If inflation becomes problematic, interest rates may continue to rise. Otherwise, the increase over the past two years may be it for some time. I can make a strong economic argument for both sides of that coin — in other words, I have no idea where interest rates are headed in the near-term. So, we are being careful with interest rate risk by limiting the duration of our portfolio and continue to insist on investing only in high-quality bonds to limit credit risk. Our bond exposure is providing a solid yield as well as a source of funds for investing in value opportunities as they come up.

If you would like to know the place bonds have in securing lifetime retirement income, see my article “The Perfect Retirement”.

Real estate is up 1.41% (Dow Jones US Real Estate)

At the end of the first quarter, real estate was down close to 6% year-to-date, and down 30% over a 9 month period. I highlighted this asset class in my first quarter client letter as a potential source of value. Since then, the asset class has fully reversed the first-quarter losses, despite the sector’s sensitivity to rising interest rates.

Commodities are up 9.94% (S&P GSCI)

Commodities are a far more dramatic version of the value we found in real estate. Since peaking in July of 2008, commodities as a broad group fell over 80% at their low point, and are only now beginning show signs of turning around (they are still down 75% from the 2008 peak). Since commodities are closely linked to inflation, it is no surprise that they performed so poorly during the lowest inflation environment in modern history. As inflation pressures increase in the coming years, commodities will be a key tool we use to address the risk of inflation in client portfolios.

I have not owned commodities in client portfolios for over 10 years, but they are being added in 2018 for the inflation protection provided, paired with historically low pricing that creates a great opportunity to build wealth.

Gold is down 3.75% (State Street GLD)

A sub-asset of general commodities, gold also went through a multi-year price decline — nearly halving the price of the precious metal. While down modestly year-to-date, gold has appreciated nicely since 2016. I always welcome pullbacks in asset prices as an opportunity to buy.

Emerging markets stocks are down 6.66% (MSCI EM) and emerging markets bonds are down 5.97% (JP Morgan EMBI)

Emerging markets spent over a decade trading sideways and not making much wealth for anyone. Late last year, the asset class finally broke out of that range and produced some very nice gains until the February 2018 market decline. Since then, emerging markets have struggled amid concerns about the value of the US Dollar and trade wars. The current decline is testing last year’s breakout and may prove to be an excellent entry point for long-term capital appreciation.

Bonds issued by emerging market countries are down similarly year-to-date. The yield on these bonds now exceeds 5.5%, and they are an attractive asset class if properly sized and risk-controlled within the context of a diversified portfolio.

The investment approach revealed in the above commentary is hopefully apparent — buy assets when prices are down and the securities are on sale. This builds sustainable lifetime wealth. Chasing the hottest stocks or picking investments based on the last year(s) winners, while comfortable at the time of purchase, has always ended poorly.

I hope you have a great weekend! Rebecca and I are picking the kids up from camp after a quiet week without them. I can’t wait to hear all their stories!

All the best,
Kenneth