In the second quarter, we expected the economy to continue to move forward, albeit with some headwinds from the Fed’s effort to normalize rates and the general political climate. While this proved to be the case, the escalation of our trade skirmish with various trading partners grabbed the attention of the markets, resulting in heightened volatility.
President Trump’s proposed tariffs on $34 billion of imports from China went into effect toward the end of the quarter, and China responded in kind targeting U.S. soybeans, aircraft and autos. These tariffs and the prospect of a progressive escalation affected markets both in the U.S. and abroad, especially in China and the emerging markets.
The optimistic view by economists is that $34 billion represents less than two-tenths of 1% of U.S. GDP – and even if you add the additional $200 billion President Trump is considering, it would still only represent about 1% of GDP. The more pessimistic view is that any trade war between the world’s two largest economies could have a significant negative impact on global growth over time, as well as being a meaningful catalyst to higher inflation in the U.S. If this persists and escalates, if could be a significant further headwind for the current bull market.
Despite tariff issues, for the three months ending June 30, 2018, markets in the U.S. were generally positive. Small caps led the way with the Russell 2000 up 7.75% and the S&P 500 up a respectable 3.43%. International stocks did not fare as well, as the developed countries (MSCI EAFE) dipped by .97%, and the developing markets (MSCI EM) fell 7.86%. REITS had an impressive rebound from last quarter’s weakness, with the Dow Jones Select U.S. REIT index finishing up 9.99%. Bonds had a quiet quarter, with the BarCap Aggregate down a mere .16%.
The path to success in many areas of life is paved with continual hard work, intense activity, and a day-to-day focus on results. However, for many investors who adopt this approach to managing their wealth, their quest for success can be turned upside down.
In the Chinese philosophy of Taoism, there is a phrase: “wei wu-wei.” In English, this translates as “do without doing.” It means that in some areas of life, such as investing, greater activity does not necessarily translate into better results.
In Taoism, students are taught to let go of things they cannot control. To use an analogy, when you plant a tree, you choose a sunny spot with good soil and water. Apart from regular pruning, you let the tree grow. In many ways, this approach applies to prudent investing as well.
This doesn’t mean you should simply do nothing. Insights from the science of investing suggest you should direct your investment efforts to the things you can control. These include taking account of your own preferences and sensitivities when choosing investment strategies, diversifying your portfolio in the appropriate areas to seek to increase returns or to manage short-term volatility, being mindful of the impact of fees and expenses, and exercising discipline when emotions threaten to push you off course.
Successful investing requires the discipline to only take actions that can have a positive impact on the outcome. One such endeavor is disciplined rebalancing. To maintain a desired asset allocation, investors should periodically rebalance their portfolio by reallocating away from strongly performing assets to those with lower valuations.
But rebalancing should not be confused with the misguided busyness of reflexively following investment trends and chasing past returns promoted through financial media. Listening to media pundits or following hot stock tips is the sort of activity that is likely counter-productive. With investing, constantly tinkering with your portfolio can add expense and do more damage than good.
At Wealth Dimensions, we build portfolios based on seeking the highest equity return for a given unit of risk, tempered by fixed income, which dampens volatility in market downturns while providing steady income. There is compelling data to support the long-term advantage of “tilting” our portfolios in certain areas of the market. However, the advantages of these tilts will not always present themselves in the short run. For example, value stocks have had a higher expected return than growth stocks over time, yet we have recently experienced a relatively long period where this has not been the case. Rather than chasing the returns growth is currently providing, we have patiently waited for an opportunity to sell into growth’s outsized rally or buy value if the spread widens even more.
Another tilt in our portfolios is to small cap stocks, which have historically outperformed large cap stocks. While there have been exceptions in various periods along the way, for the most part, small cap stocks have performed very well in comparison to large caps in the recovery from the Great Recession. At some point, our analysis will show a time to rebalance by taking our gains in small caps and rebalancing to large caps.
In theory, rebalancing seems like a simple process, but human nature is such that most investors find it to be most difficult in practice. Greed causes investors to be tempted to stay in when they should be paring back, and fear causes them to be frozen when opportunity presents itself. And the wisdom of wei wu-wei coaches us to use care in not “over managing” by reacting to every piece of news or advice that comes our way.
In January this year we began the process of converting our internal portfolio management software system from Interactive Advisory Software to Orion Advisor Services. This new software system will not only provide additional internal trading capabilities and efficiencies, but will also provide considerably more flexibility in reporting. In the coming months, we will begin to roll out a more customized reporting experience, as well as the option to receive your reports electronically. We look forward to these enhancements to our capabilities in serving you.
Thank you for your continued confidence in our services.
Information provided has been prepared from sources and data we believe to be accurate, but we make no representation as to its accuracy or completeness. Data and information is general in nature and not meant as specific to any particular situation. As such, you should not act on this information and should seek advice based on your particular circumstances. Wealth Dimensions Group, Ltd, shall not be liable for any errors or delays in the content or for the actions taken in reliance therein.
Please be advised that this material is not intended as legal or tax advice. Accordingly, any tax information provided in this material is not intended and cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.