Global stock markets experienced a number of low-scale tremors in August and September that seemed to shake the confidence of many investors. As with geological tremors, the events of the third quarter—increasing concern about China’s economy accompanied by a surprise Yuan currency devaluation, a subsequent tumble in global stock markets, and the Federal Reserve’s decision not to increase rates—are indications of a global economy that is not without its fault lines.
It is also the case that ups and downs should be expected as a typical part of any market cycle. In fact, the current market stands out for the unusually long time (six and a half years, to be exact) it has lasted without a bear market decline, defined as a drop of 20% or more. So while this round of market bumps has triggered the usual fear-driven news headlines, in our view nothing has broadly changed, except that foreign markets have gotten a bit cheaper and are a bit more appealing from a valuation standpoint. We would also note that while we’re not in the business of predicting downturns, we think it’s prudent to be prepared for them nonetheless. The reality of owning stocks is that occasionally, inevitably, we will experience declines of varying severity over time. For the quarter overall, stocks were down 6.5% while bonds rose 1.2%.
Another key ingredient in managing through market declines is helping you accurately assess your risk tolerances and investment objectives. If you are in an appropriately structured portfolio, there is no benefit to selling in a downturn. In fact, by doing so you risk selling nearer to the bottom and then missing the subsequent recovery.
We are likely to view downturns as potential buying opportunities—exemplified by our tactical moves since the end of September. This is based on our tactical asset allocation approach that centers on analyzing long-term fundamentals and valuations, while remaining sensitive to shorter-term portfolio risks. For example, emerging-markets stocks may have been the biggest losers in the recent downturn, but our return estimates indicate they are now poised to outpace U.S. stocks materially over the next five years across a wide range of economic scenarios.
In an uncertain world, it is impossible to confidently predict the direction of financial markets. But we can more confidently evaluate a range of possible scenarios in order to understand the scope of potential returns for one investment or asset class relative to another. Our objective is to always emphasize undervalued investments and de-emphasize overvalued investments while building a portfolio that we believe will deliver the highest long-term return in line with each client’s risk tolerance.