Summer 2013 Market Update: With Global Stock And Bond Markets Suffering, Investors Should Remain Patient

With U.S. bond markets and global stock markets in a tailspin this year, investors and investment advisers are keeping a close eye on markets and government action. Although the U.S. stock market is still near all-time highs, the Federal Reserve’s recent announcement that they will soon end the quantitative easing program and additional global growth concerns have caused bear markets in many global stock markets and even in domestic bond markets.

Bond Markets

The U.S. long-term bond index is down 11% year-to-date, but nearly 13% in just the last 6 weeks. This is the most significant downturn in bond markets since the 2008 crisis and the bond market is on pace for its worst annual loss of the last 85 years. Why is the normally stable bond market down this year? As we’ve discussed in previous newsletters, the Federal Reserve has kept interest rates at zero and engaged in quantitative easing to boost lending and economic activity. One side effect of this action though is that we ended up in a bond bubble and we’re now seeing the short-term price declines as a result. While we fully expect the bond market to “normalize”, there still may be some more short-term pain for bond investors.

Global Stock Markets

With the U.S. stock market still near all-time highs, it’s easy to ignore that many global stock markets have been suffering greatly this year. The fastest growing economies in the world have seen slight slowdowns in GDP growth, while other corners of the globe like Europe are mired in the second recession in the last 5 years. Both of these problems are temporary, but are having strong effects on markets.

Emerging markets like Brazil, Russia, China and Mexico are all down more than 20% over the last year, while countries like Spain and Italy are seeing 20% gains. This does not mean emerging market countries should be avoided by investors however. We use purely statistical and unemotional research to find value globally and we see emerging market countries as offering investors strong long-term value and potential growth.

What Should You Do Now?

During and after the stock market crash of 2008, many investors thought advisers should have done something to help them avoid losses. Markets of all kinds suffered, except for bond markets at the time, and “doing something” meant exiting the stock market and investing in bonds for many. This may have seemed wise at the time, but market timing like that caused many to miss the massive market bounceback and it turned out to be the costliest investment mistake of their lives for many investors.

Despite the market turmoil, you will get no market timing advice from us. We view market timing as a form of gambling and it almost always turns out badly for investors. Time the market wrong and you could be selling low only to miss the recovery of the market you’ve just exited.

A better idea is to create a solid long-term portfolio plan and stick to it unless the reasons you designed the plan in the first place change. Unless major life changes have occurred, sticking to your plan and being patient will help you make it through tough times. And even though market drops seem painful, short-term swings don’t impact our lives while long-term plans do. Like all downturns, the bond and emerging market downturns will pass and those investors who’ve been patient will be rewarded. Because we act as our clients’ fiduciaries, we try to remove emotions from the decision-making process and help investors stay the course.

To illustrate how important it is for investors to stay patient, take a look at the chart below. It shows the S&P 500 index since 1973. You’ll notice two large drops, one in 2002 and one in 2008. We have highlighted the “bounceback” period to show what could have been missed by those who timed the market wrong. It’s important to see that if an investor were to pull out of the market during one of these downturns, they could easily have missed the best performing market eras of the past 25 years.

That shows some recent stock market recoveries, but here’s some interesting information about the history-making bond market downturn we’re now seeing as well: The bond market has only had two down years since 1975 and it rebounded the next year 18.47% and 11.63% respectively.

Traditionally bond markets provide stability and stock markets provide returns. History backs this claim up strongly. Since 1928 the bond market has only had 15 “down” years while the S&P 500 stock index has had 24 down years. But $100 invested in T-Bonds in 1928 would now be worth $6,926.40 where $100 invested in the S&P 500 would be worth $193,219.24. To put it mildly, patient investors are rewarded for accepting more downside with stocks, but bond investors achieve the stability goal as well.

We won't predict the future, but going by the fact that the economy is healthier now than 5 years ago, a significant recovery could be in store for the bond and emerging markets.

Data Sources:

Barclays Capital US Aggregate Bond Index Factsheet 1976-1983; Callan Chart 1984-2004; Ishares Performance 2004-2010

Aswath Damodaran, Ph.D., Stern School of Business, NYU. Retrieved online June 25th, 2013.