In the last month, stock markets around the world have been adjusting expectations. Managing market expectations about the future is 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 the sell-off in May. The global economy is growing. But this grown will slow if trade negotiations lead to higher tariffs and Brexit continues its rudderless course.
Managing market Expectations
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 throughout 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, 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.
Mastering the Market Cycle
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 seven out of ten times at 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. However, they too are operating in a complex environment with many factors at play. As an example: If trade issues were magically resolved tomorrow, we would still wonder how that affects the Federal Reserve. 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.
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