Where are the Winners? (11/27/2018)

The year 1994 was a difficult investing period, when both stocks and bonds were down.  History may be repeating itself this year. The November 26, 2019 edition of the Wall Street Journal noted that Deutsche Bank, which tracks 70 asset classes, indicated that 90% were posting negative total dollar returns through mid-November. “That is on track for the highest share since 1920, when 84% of 37 asset classes were negative,” the WSJ stated. In comparison, only 1% of asset classes were negative last year.

We use a system known as Modern Portfolio Theory to manage assets. This approach does not attempt to predict the best performing asset class each year, in hopes of getting big returns. Because having all of your investments in one or two asset classes could result in significant losses, we instead use diversification among many asset classes. Based on the level of risk an investor is willing to take, this approach creates a blend that will hopefully cushion our level of losses in bad years, but in good years will give us reasonable results.

Normally, the use of broad diversification results in some assets doing better than others, which tends to lower volatility and risk. When 90% of all asset classes are down, diversification doesn’t work. This is one of those years when it appears we have no winners yet!

The U.S. economy is doing well. Corporate earnings are up, and spending on capital improvements has been significant this year.  Consumers are earning more and spending more.  The negative impact is coming from a slowing world economy, U.S. tariffs, and the fear that these can impact the U.S. economy. With the Federal Reserve raising interest rates, the cost of financing by individuals and corporations is up. The higher interest rates in the U.S. are bringing more foreign investment into the U.S. and thereby raising the value of the dollar. As the dollar gets stronger, foreign currencies become cheaper. This is difficult for U.S. exports, as the foreign cost of U.S. products and services becomes more expensive

As the world economy slows, the price of oil has dropped, lowering profits; the cost of mortgages has risen, making housing purchases more expensive; interest on bonds has climbed (reducing the value of bonds); stock investors are worried about long-term earnings of corporations; and the U.S. economy seems vulnerable.

If we take a longer view, we can see that the rise in interest rates means, that as our current bonds mature, we will be earning more money on the new bonds we buy. As the cost of oil drops, the cost of manufacturing products in which oil is a major factor, will drop. If the Federal Reserve sees higher interest rates harming the economy, they may not continue to raise interest rates. Maintaining level interest rates may give consumers and corporations more confidence. In addition, how likely is it that 90% of all asset classes will be down again next year?

Going back to 1994, when both bonds and stocks were down, we saw an incredible rally in 1995. The investments that corporations made in technology increased productivity and thereby earnings.  Wages rose and consumers spent money.  Could this happen in 2019?

Ed Mallon 

November 27, 2018