Stocks rallied at the end of November after a volatile month. Global stocks finished the month up 1.5%. Defensive sectors led the market as healthcare and real estate stocks gained 7% and 5.5%, respectively. Shares of tech companies felt pressure, declining 2%. The energy sector sold off as a result of the sharp pullback in oil prices.
After lagging for most of 2018, international stocks stabilized versus domestic stocks, suggesting some optimism is forming around the China-US trade tensions.
Bond yields moved lower. Stock market gyrations and dovishness from the Fed Chair helped the 10-Year yield dip back down to 3%. The Bloomberg Barclays US Bond Aggregate gained a modest 0.6% but is down 1.8% for the year.
A rocky autumn wiped out most of the stock market’s gains for the year and left many investors feeling less enthusiastic for a market unable to sustain upward momentum. In the last two trading days, the Dow Jones Industrial Average has gyrated from 492 points up on news of a trade war truce with China to a 799-point loss after a less positive interpretation of said truce. The AAII Investor Sentiment survey recorded twice as many bears as bulls in the second to last week in November, marking the most bearish reading since 2016.
But, we can all be thankful we didn't swap our dollars into bitcoin this year. The cryptocurrency fell 37% in November, bring the losses in 2018 to 73%.
The King is Back (for Now)
After above average gains for stocks in 2017, 2018 is setting up to be another unusual year for a different reason. So far this year, cash is king. All major asset classes have lagged the performance of cash. The MSCI All-Country World Stock Index is down 2.6% this year, and US Bonds are off 1.8%. US Treasury bills, the traditional measure for cash, are up 1.6%.
It is rare that cash beats stocks and bonds. Since 1928, stocks outperformed cash 68% of the years, and bonds beat cash 60% of the time. Cash has only come out on top 12 of 90 years or 13% of the time.
Just because cash is on top for 2018 doesn't mean that taking risk won't be rewarded in the future. Over time, stocks and bonds should beat cash as they are riskier in the short term.
But what about those 12 years? In most cases, those years experienced some shock that resulted in higher short-term interest rates. That unexpected change in conditions forced a sudden repricing of future interest rates, forcing the market on its heels.
Today's environment is similar. The bond market has consistently challenged the Fed's rate-hiking intentions. Inflation appears to have found a higher base, and there is a risk that trade tensions could lead to more inflation. Recent tax cuts and rising deficits added a sugar rush into a decade-long economic recovery. The days of 'lowflation' may finally be gone.
These adjustments are a natural part of the back-and-forth between central banks and financial markets. It has happened before, and it will happen again. But history suggests it wouldn't be wise to bet on cash as a long-term strategy.
What We are Doing: Lemonade from Lemons
The recent rise in interest rates combined with increased volatility in stocks has created opportunities for rebalancing and tax-loss harvesting in taxable accounts.
In the last few months, we have been evaluating client portfolios for potential losses.
As interest rates rise, bond prices decline, creating unrealized losses in some investment positions. By rotating from the existing bond into a similar but slightly different bond, we can avoid IRS “wash sale” rules. That allows us to maintain the same long-term investment strategy and still realize the loss for tax purposes, reducing tax bills.
These opportunities can mean real savings when it comes time to pay Uncle Sam. With trading costs and commissions as low as ever, there is little downside to this tax reduction strategy.
Capital losses can be used to offset any capital gains plus an additional $3,000 in any one year. Any excess losses may be carried forward for subsequent years, creating a tax shelter for future gains.
Realized gains and losses are not the same as investment returns.In fact, the two may be very different in any given year. While no successful investment strategy can eliminate gains forever, we try to defer tax as long as possible. Carefully evaluating and harvesting tax losses is an important component of our portfolio management strategy.
What It All Means
Cash may be a part of your long-term investment strategy. Holding cash helps manage on-going liquidity needs and can buffer the market’s ups and downs. Yet as a long-term growth strategy, cash returns struggle to keep pace with inflation. Real inflation-adjusted growth is still the job of stocks and bonds. The right mix of stocks, bonds, and cash is the one that allows you to stay the course through times of exuberance and fear.
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DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Proffitt & Goodson, Inc. makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. The information is subject to change and, although based on information that Proffitt & Goodson, Inc. considers reliable, it is not guaranteed as to accuracy or completeness. Source information is obtained from independent financial data suppliers (Interactive Data Corporation, Morningstar, etc.). The Market Categories illustrated in this Financial Market Summary are indexes of specific equity, fixed income or other categories. An index is a reflection of the underlying securities in a particular selection of securities picked due to a particular type of investment. These indexes account for the reinvestment of dividends and other income, but do not account for any transaction, custody, tax, or management fees encountered in real life. To that extent, these index numbers are artificial and cannot be duplicated in real life due to the necessity of paying those transaction, custody, tax, and management fees. Industry and specific sector returns (technology, utilities, etc.) do not account for the reinvestment of dividends or other income. Future events will cause these historical rates of return to be different in the future with the potential for loss as well as profit. Specific indexes may change their definition of particular security types included over time. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of Proffitt & Goodson, Inc. Past performance does not guarantee future results.