Staying the Course: Five Ways to Prepare Today

By Kate Warne October 02, 2017

Man backpacking in mountans

Stocks sprinted to new highs in 2017 without their usual accompanying volatility, helping investors remain cool and unfazed despite elevated economic policy uncertainty, political acrimony, rising short-term interest rates and still-slow economic growth. Although U.S. stock market valuations are above-average, we think stocks can keep rising based on modest U.S. economic growth and rising earnings, as well as accelerating global growth. However, the calm environment may not continue, and future returns may not live up to elevated expectations.

Calmer for longer

Smart investors have stayed invested despite worries that could trigger higher volatility over time, including:

  • Recession forecasts – As the economic expansion moves through its ninth year, mixed economic signals have prompted speculation about the timing of the next recession. Slower vehicle and housing sales – two of the most cyclical contributors to the economy – are worrisome. But we don’t see broader signs of a looming recession. The rebound in manufacturing after last year’s pause is providing new fuel, and hoped-for tax cuts in 2018 could also bring faster growth. Consumer confidence has soared, as the chart shows, due to still-strong job growth. That’s positive for rising consumer spending, which powers two-thirds of economic growth.
  • Above-average stock valuations – Stretched valuations can make stocks more sensitive to disappointing earnings, but in 2017, better-than-expected earnings and faster sales growth have reduced those concerns. Above-average valuations are frequently followed by below-average returns, though, which is why we think investors need to maintain realistic expectations for stock returns over the next 5-10 years.
  • Elevated economic policy uncertainty – Historically, uncertainty about the direction of economic policy has meant higher market volatility, and that relationship could re-emerge. But continued gridlock in Washington, combined with modest regulatory relief and easier borrowing conditions, seems to have been enough to keep investors and markets calm.
  • Less support from monetary policy – The Federal Reserve plans to continue to raise short-term interest rates at a slow pace and to start reducing its $4.5 trillion balance sheet by not replacing maturing bonds. Although past shifts in Fed policy have triggered pullbacks, markets haven’t reacted because these moves have been slow and communicated well in advance. In addition, foreign central banks are continuing their expansionary policies.

Sources: Ned Davis Research, Inc., The Conference Board, Bloomberg and Edward Jones calculations, 2/28/1969-6/30/2017. Past performance is not a guarantee of future results. Copyright © 2017 Ned Davis Research, Inc. All rights reserved. Further distribution prohibited without prior permission.

Rising geopolitical risks – Conflicts could worsen as foreign leaders jostle for power and try to gain advantage from changing U.S. policies. Accelerating economic growth in the rest of the world helps improve prospects domestically, adding to the power of increasingly optimistic consumers. Our outlook for U.S. economic growth and markets is positive but realistic, as challenges lie ahead.

Realistic expectations

The past year’s above-average U.S. stock returns may not continue. As the chart shows, high consumer confidence was followed by low stock market returns over the following year – the Dow was up only 0.6% on average.1

Stocks have been said to climb a wall of worry, and that seems to be true since the most recent market correction in early 2016. As they climb that wall, stocks usually drop by 10% or more about once a year, with three or four smaller pullbacks of 5%. But in the more than 18 months without a single 5% pullback, some investors may have forgotten how volatile stocks can be.

What can you do to position your portfolio for the possibility of lower returns with more volatility? We recommend five moves:

  1. Review and rebalance your portfolio’s mix of stocks and bonds, if necessary, based on your comfort with risk and time horizon.
  2. Add cash – Although short-term interest rates remain extremely low, cash reduces portfolio volatility and can help you add investments when prices drop.
  3. Add investment-grade fixed income – Bond prices frequently rise when stock prices drop, helping stabilize the value of your portfolio. Historically, investment-grade bonds have outperformed stocks on a rolling one-year basis about one-third of the time since 1976.2 Don’t underestimate the importance of owning bonds if markets become more volatile over time.
  4. Add international developed-market stock investments, which began to lead U.S. large-cap stocks in the first half of 2017 after lagging for several years. They don’t always move in sync with U.S. stocks, but we think accelerating global growth and the possibility of further declines in the dollar can help them continue to perform well.
  5. Reduce commodities, high-yield bonds and international bonds – In our view, these investments may not provide high enough returns to compensate for their risks.

A realistic and proactive approach with a well-positioned portfolio can help you keep calm and stay invested over time. Contact your financial advisor today to help ensure your portfolio is properly positioned for whatever lies ahead.

Important Information:

1 Past performance is not a guarantee of how the market will perform in the future.

2 Source: Morningstar Direct. Investment-grade bonds represented by the Barclays U.S. Aggregate Bond Index. Stocks represented by the S&P 500 Index.

Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events. Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.

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