The first half of 2021 has been a good one for investors. On the back of a reopening global economy markets at home and across the globe have performed better than many expected. When one considers the performance of the equity markets in 2019 and 2020 the investment environment looks even brighter. That June was a mixed month – some equity indexes higher, some lower – does not diminish the growth of these indices over the previous 30 months.
The US Dollar Index, the CRB Commodities Index, and the Aggregate Bond Index were all strong in June.
U.S. & International Stock Index Returns
|Index June 2021 Year-to-Date|
|Dow Industrials (0.09%) 12.73%|
|S&P 500 2.48% 11.93%|
|S&P 400 (Midcap) (1.35%) 16.89%|
|S&P 600 (Small Cap) 0.26% 22.87%|
|MSCI World 1.54% 12.16%|
|MSCI EAFE (1.35%) 7.33%|
|MSCI Emerg Mkts (2.22%) 6.46%|
|Bloomberg Barclays Agg. Bond (1.60%)|
|CRB Commodity Index 27.17%|
|US Dollar Index 2.74%|
All data as of 07/01/2021, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
In talking to both clients and prospects the one overriding theme we hear on the topic of their investment portfolios is that of disbelief. Good disbelief.
Something like: “Why hasn’t the stock market gone down? When will it go down?”
Normally, coming out of a recession (don’t forget that 2020 was a bad year economically … the pandemic shutdown and all) the stock market is recovering from a bear market drop and investors are licking their wounds. Government action, combined with PPP loans and direct payments to the majority of Americans, had a positive effect on the economy. People had money to spend on what they could; businesses were able to manage through some tough times in a closed economy. This time it really was different.
And now we enter the second half of the year where things are looking pretty, pretty good. Economic activity remains strong, seemingly held back because of supply chain issues keeping people from spending more money faster. Full year earnings for the S&P 500 continues to be upgraded. Interest rates have remained low, even as inflation rises and The Fed has talked about raising short-term rates up in late 2022
But …. Anyone who’s been around the markets for more than a minute knows that markets do not go straight up or straight down. No matter what you call it – “correction” or “counter-trend” rally/dip – there will be moves that go against the greater trend. And, as we argued in our May 2021 Report, we believe that we are in a secular bull market that began in 2013. That tells us that that, over time, we can expect the stock market indices to continue to move to higher levels.
What happens in the short- to intermediate-term, however, can be a much different story. Emotions can get in the way when things go bad for even just a few days or weeks. We have stories of investors who panicked, didn’t take advice, then watched a good year for the market indexes turn out to be a not-so-good year for them. Investors can be their own worst enemies. We also have stories of clients who chased performance only to see that blow up as well.
We know this empirically, but we also know how investors react thanks to the Dalbar study of investor performance that lays it out in a simple to understand report. In the 20-year period from 01/01/2001 through 12/31/2020 the average equity fund investor had an average yearly return of 5.96% vs. the S&P500 Index at 7.43% and a global equity index returning 8.29% per annum.
Emotions and Markets
We mention this propensity to underperform by the average investor at a time when, in our opinion, investors can start making mistakes. Right now we see the stock market as vulnerable to a correction, which is when emotions can get the best of us and we make poor investment decisions. When markets correct it is best to sit on our hands (or better yet, add to our investment portfolio) and ride out the volatility. Sure, seeing smaller values on our statement isn’t what we want to see, but it is a temporary situation. It is going to happen from time to time. In these situations, patience should be your best friend.
We do think that the potential for emotional investment decisions is higher than usual right now precisely because there has been so little volatility in the stock market. So far this year the market is up 14% with the largest drawdown being a paltry 4% (chart #2). In our experience, this is a setup for bad decisions.
Is a “Correction” On the Horizon?
Nothing, of course, is guaranteed in the markets. On more than one occasion all indications were something was going to happen before it didn’t.
This is how markets work.
This is why you don’t want to react to the “noise” in the markets.
This is why you want the secular trend to dictate how you react to perceived or real short-term trend changes.
This is why you don’t react to what could or should happen.
What we are seeing is stock market indexes making fresh new all-time highs as more individual stocks lose momentum. This shows up in the Advance/Decline Line, the number of stocks above their 200 Day Moving Average, and the number of stocks above their 50 Day Moving Average. Essentially, we are in a market where a smaller number of individual stocks – most often those with the largest market capitalizations – are pushing the indexes higher. In our experience this scenario often leads to lower markets in the short to intermediate term.
When it comes to the markets there is never a sure thing. After a great start to the year for the stock market we see a more likely scenario for either sideways or down markets in the coming months. All indications are this is a temporary situation, not the end of a bull market.
Investing is both simple and hard. How you control your emotions matters, not when things are going well, but when they are going either great or poor. This could be one of those times. If, indeed, we are correct in our assertion that the stock market is on the verge of a correction, our believe is the best path forward for investors is to not panic. Ride the volatility out. Don’t panic sell. Maybe put some cash to work.
We remain bullish on the stock market for the long term.
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Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
Jeffrey T. Bogert, Partner
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com