In the last month, stock markets around the world have been adjusting expectations. Expectations about the future are important because often it is not a matter of economies being good or bad that drives shares higher. Of greater concern is whether the economy is getting better or worse. The U.S. economy growing at 2% instead of 3% is still growth, just at a slower pace. That expectation of a slower pace is what drove May’s sell-off. The global economy is growing, but more slowly if trade negotiations lead to higher tariffs and Brexit continues its rudderless course.
Adjusting expectations lower has meant stock market declines, but that has also created a flight to safety. Bond yields have dropped steeply in recent months, which means that investors have been rewarded for keeping high quality bonds as ballast. The low returns that we saw on fixed income through the first few months of the year felt reassuring as bonds rallied into the stock sell-off. Here were the monthly total returns on some of the major indices:
S&P 500: -5.65%
MSCI All Country World Index: -5.92%
Barclays US Aggregate Bond Index: 1.75%
It is always a valid question to ask whether a bad week, of month, or quarter should call into question the way that you are invested. In reality, the good businesses that you invest in have to operate every day in an uncertain environment as existed in May. Howard Marks, in his book Mastering the Market Cycle, describes how businesses have to face unpredictable conditions much like a hitter in a baseball game. A Hall of Fame hitter with a .300 lifetime average still failed to get a base hit 7 out of ten times to the plate. A hitter of that caliber was capable of greatness in every at-bat, but forces out of his control were also at play. Here are some of the factors that hurt a hitter’s consistency, according to Marks: His health, the weather, stadium lights, the crowd, the game situation, the quality of pitches, his guess of the next pitch, his diet that morning, his bed time the night before. In a vacuum he might hit a home run every trip to the plate, but no at-bat ever takes place in a vacuum.
We are watching trade negotiations and interest rates very closely, but they too are operating in a complex environment with many factors at play. If trade issues were magically resolved tomorrow, we would still wonder how that affects the Federal Reserve, for example. Every diversified portfolio is designed to weather multiple events and developments. Our job as investors is to not become so consumed with one story that we lose our appreciation for complex economies.
Here some interesting pieces related to expectations that caught our attention in the last month:
Churchill: Walking with Destiny. My recent book project…Managing the expectations of a nation at war when nothing is certain.