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Climbing the “BrIC Wall”

February 14, 2019

From its peak on 9/20/18 to its trough on 12/24/18, the market (as measured by the S&P 500) declined 19.8%. But in keeping with the adage, “stocks climb a wall of worry,” the S&P 500 has rebounded more than 15% through 2/08/19.

 

 

This climb has occurred in the face of much uncertainty, which we will collectively call the BrIC Wall.

 

  • Brexit – British Prime Minister, Theresa May, continues to try to rework the country’s deal with the European Union (EU).  With seemingly little progress made in her meetings in Brussels, there remains significant concern that Britain will exit with “no deal.” The treatment of the border between Northern Ireland and Ireland (the gateway to the EU) is at the center of the debate.  The outcome will greatly affect trade, economic growth, and investment in Europe. The U.S. will likely feel some ripple effects as the U.K. remains our fifth largest export market and American companies have invested nearly $600 billion in the British market (which represents more than 12% of all U.S. foreign direct investment worldwide).

 

  • Italy – The tension between Italy and the EU also continues to grow not only because the country appears to be aligning itself closely with Britain, but also because of its tenuous economic situation.  With debt to GDP of 133% (second only to Greece in Europe), an economy that has recently hit recession territory for the third time in 10 years, and a budget deficit of 2.04% of GDP that narrowly passed EU approval, many investors have concerns about potential default and/or an Italian exit from the EU. 

 

  • China – The March 1 deadline for US-China trade talks is rapidly approaching and optimism that progress will be made remains high.  While a complete resolution is unlikely, the market appears to be hoping for progress in the form of an extension beyond the March 1 deadline so that talks can continue.  The broader, related story is slowing global growth.  The Chinese economy expanded 6.6% in 2018; its weakest pace since 1990. The news of the day on trade and global growth continues to greatly impact the mood of the market. 

 

  • Wall – The last and longest US government shutdown in history (34 days) was caused by an inability for the administration and Congress to agree on the best approach to border security between Mexico and the southern border of the United States.  The impact of the prior shutdown seems to have had less of an effect on the economy than many feared, but the possibility of another shutdown looms, which could further dent confidence in the government and the economy. It appears that we could have some clarity on this issue by the end of the week.

 

The problem with uncertainty is that it creates worry about the future, which leads to volatility in the present. Investing in stocks requires not only confidence in the future, but also willingness to stomach substantial swings in asset values as the chart below shows.

 

 

The red in the chart depicts every drawdown of the S&P 500 on a rolling daily basis from 1950 to present. Over that time period, the average drawdown was -9.9% and the worst drawdown was -56.8%. Additionally, since 1950, 17% of the days reflected a loss of 20% or more from the prior peak. Of course, investors have been rewarded for this risk.  Despite the frequent and sizable drawdowns, $100,000 invested in 1950 would have resulted in $15,047,119 by 12/31/18 (excluding dividends).

 

Attempting to mitigate downside risk of stocks is one of our most important jobs, particularly for clients who are drawing down on their funds or are highly sensitive to short-term swings in the market.  For those investors, we believe one of the best ways to mitigate risk is to invest an appropriate portion of money in bonds. 

 

As the chart below shows, adding bonds has historically decreased the range of potential outcomes – softening the downside, while also limiting the upside.

 

 

With the market having rebounded nicely from its lows on 12/24/18, now is as good a time as any to assess your risk tolerance and your current allocation. Please do not hesitate to contact us if you would like to discuss your allocation.

 

 

 

 

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Sources and Disclosures:

https://tradingeconomics.com/united-states/adp-employment-change,

https://www.cbpp.org/research/economy/chart-book-the-legacy-of-the-great-recession

https://www.uschamber.com/international/europe/us-uk-business-council/us-uk-trade-and-investment-ties#end3

Source for S&P 500 Level % Change:  ©Y-Charts. The chart above is for illustrative purposes only and is not intended to be investment advice. The data contained herein are gathered from sources believed to be reliable; however, they cannot be guaranteed as to their accuracy or completeness. Past performance is not indicative of future results. An investor cannot invest in an index and index returns are not indicative of the performance of any specific investment. Index performance does not reflect the expenses, fees, and taxes generally paid with the active management of an actual portfolio. The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. It focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market. 

 

Source for Drawdown Chart: Daily index values obtained from Yahoo Finance from 1/1/1950-12/31/18. The chart is for illustrative purpose only and is not intended as investment advice. Past performance does not guarantee future results. The S&P 500 Index is a market cap weighted basket of 500 leading companies in the U.S. that capture 80% coverage of available market capitalization. Indices cannot be invested in directly. Drawdowns represent the percentage decline in index value from the previous peak. Price Return does not take into account the payment or reinvestment of dividends.

 

Source for 1-Year Rolling Returns Chart: Monthly index values obtained from © YCharts from 1/1/99 – 12/31/18. The charts are for illustrative purposes only and are not intended as investment advice. Past performance does not guarantee future results. Stocks are represented by the S&P 500 Index and Bonds are represented by the Barclays Aggregate Bond Index. The S&P 500 Index is a market cap weighted basket of 500 leading companies in the U.S. that capture 80% coverage of available market capitalization. The Barclays Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.  Indices cannot be invested in directly.

 

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Alpha Omega Wealth Management, LLC-“Alpha Omega”), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Alpha Omega.

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