Markets Update: A Quarter in Review
Uncertainty has become the central theme around investing, economics, and geopolitics in 2019. This uncertainty has led businesses to defer investment and could lead to a slowing in hiring, both of which threaten to push the economy close to recession. Global Central banks quickly pivoted from raising interest rates in the latter half of 2018 to cutting interest rates this year in reaction to a slowing economy. We expect rate cuts to continue with the likelihood of one additional rate cut occurring in the U.S. already being priced into the market. With this, discipline around diversification and rebalancing remains very important in your portfolios.
BONDS
Fixed income had a good quarter. U.S. bonds returned 3.08% and global bonds earned 2.75%. The Federal Reserve began lowering interest rates during the third quarter, quickly enacting two rate cuts in July and September, with one additional cut expected in 2019 and another forecasted by early 2020. Other major central banks are keeping policy easy in the face of uncertainty around global trade and sagging inflation.
STOCKS
Equity markets continue to be whipsawed by the ever evolving news around a U.S.-China trade deal, Brexit, and geopolitical tensions. While all stock indices remain positive for 2019, year-to-date, the 3rd quarter was a mixed bag. U.S. stocks returned 1.16% for the quarter, with international stocks and emerging markets stocks both seeing negative returns at -1.7% and -4.11% respectively. While resilient to this point, persistent uncertainty from protectionist policies is denting business confidence and slowing business spending. There are inklings of a trade deal between the U.S. and China, but such a trade deal is probably not going to be comprehensive and even less likely to address some of the core differences between Beijing and Washington. Any deal would be better than the current uncertainty. All together we see volatility continuing through the final 3 months of the year with the most likely outcome being low single digit returns to either the upside or downside. That said we remind ourselves to expect the unexpected and don’t rely on short term forecasts to drive your investment strategy.
Economy
The global economic growth has slowed but remains positive. The labor market remains robust with the unemployment rate dropping to historical lows while consumer spending remains a key support for the U.S. economy. Yet, U.S. and global manufacturing are in recession territory, driven by uncertainty around trade and shifting supply chains as a result of tariffs. Based on the economic indicators we follow, the probability of a U.S. recession in the next 12 months has increased slightly but remains low. This suggests two things: 1) Resilience from a diversified portfolio across stocks, bonds, and geographies is even more important today. 2) Moderate risk-taking will likely be rewarded given that central banks are supporting easy monetary policy. We are prepared for both attractive buying opportunities caused by market pullbacks and potential for solid returns as global central banks are highly motivated to avoid a recession in the near term.
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Topic of the Quarter: Value Judgments: Viewing the Premium’s Performance Through History’s Lens
There’s a misconception in the markets: value stocks have lost their vigor.
Value stocks have underperformed growth stocks over the past decade. In the US, the annualized compound return has been 12.9% for value stocks, or those trading at a low price relative to their book value. That contrasts with 16.3% annualized compound return for growth stocks, or those with a high relative price.1
LESSONS OF THE PAST
Value underperforming growth by 3.4 percentage points a year over a decade is indeed disappointing. But one question investors might ask themselves is, how do the returns for value and growth stocks over the past decade compare with their long-term averages?
Looking at returns for the US value and growth indices separately in Exhibit 1, we see that growth’s annualized compound return of 16.3% over the 10-year period ending June 2019 was much higher than its return since July 1926, at 9.7%. On the other hand, value performance over the past decade has been more or less in line with its historical average: 12.9% vs. 12.7%. We can see value has performed similarly to how it has historically behaved. It is growth stocks that have had very good recent returns relative to the long-term history. Investors maintaining an emphasis on growth stocks may be hoping this departure from the trend will endure, despite the historical long-term averages.
How do recent returns for value and growth stocks compare with their long‑term averages?
EXHIBIT 1. OUTLIER DETECTOR
Performance of US Value Stocks In past 10 years and since 1926, and performance of US growth stocks over the same periods.
As of June 30, 2019. In US dollars. Fama/French indices provided by Ken French. See Index Descriptions in the appendix for descriptions of Fama/French index data. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
EXHIBIT 2. LEAP YEAR
Using March 31, 2000, and March 31, 2001, as ending points, performance of US value and US growth stocks over 1- to 15-year trailing periods.
A QUICK COMEBACK
While stock returns are unpredictable, there is precedent for the value premium turning around quickly after periods of sustained underperformance. For example, some of the weakest periods for value stocks when compared to growth stocks have been followed by some of the strongest (see Exhibit 2). On March 31, 2000, growth stocks had outperformed value stocks in the US over the prior year, prior five years, prior 10 years, and prior 15 years. As of March 31, 2001—one year and one market swing later— value stocks had regained the advantage over every one of those periods.
POSITIONED FOR THE LONG TERM
The theoretical support for value investing is longstanding—paying a lower price means a higher expected return. However, realized returns are volatile. A 10-year negative premium, while not expected, is not unusual.
But history also tells us that changing course after a disappointing spell for known premiums can lead to missed opportunities. When those drivers of outperformance have turned around in the past, steadfast investors have been rewarded. A key to successful long-term investing is sticking with your approach, even through difficult periods, so that you are there for the good times too.
In US dollars. Fama/French indices provided by Ken French. See Index Descriptions in the appendix for descriptions of Fama/French index data. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
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