“New highs are almost always good news; it’s just the last one that is not.”
– Greg Morris
“A bull market is a bull. It tries to throw off its riders.”
– Richard Russell
March was another great month for investors. Unlike 2023, when equity returns were dominated by a small number of the largest technology stocks, 2024 has been much more balanced between the various equity markets we follow. The two markets that continue to significantly lag are the S&P 600 (small cap) and Emerging Markets. Commodities posted a positive gain of 6.78% with the US Dollar continuing to show strength. Bonds have been the laggard, up 1% for the month but negative for the year.
All data as of 04/01/2024, Source: Wells Fargo Investment Institute. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results. [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.]
Last month we made the case for the stock market. Specifically, we made the case that stock market leadership was not a one-trick pony of mega-cap technology stocks, but a much broader base of companies and sectors that were thriving in the current environment. Fortunately, the stock market agreed with us, producing not only great returns in March but a great first quarter of 2024.
This month we want to take a step back and remind you that markets tend to move directionally, but those moves don’t happen linearly. Put another way, within every bull market and bear market there will be counter-trend movements. After a first quarter that has produced gains we think many of us would be happy with for an entire year, it is worth considering that a stock market correction is a real possibility.
How real of a possibility you ask? Very real. Chart #1 illustrates yearly returns for the S&P 500 starting in 1980 with the intra-year declines noted. What it shows us is that even with returns positive in 33 out of 44 years, the average yearly intra-year drop was 14.2%.
Chart #1: JPMorgan 1st Quarter 2024 Guide to the Markets Past performance is not a guarantee of future results.
This leads us to our topic this month – investment risk management.
To some, investment risk management is all about placing hedges on a portfolio. Some examples would be utilizing a variety of strategies that utilize the options markets, holding cash in place of equities, or purchasing an ETF or mutual fund that invests for inverse returns to a stock market index. At Magellan Financial we see all these hedging strategies as making a “bet” on what the stock market is doing in the short-term. It is not what we believe to be proper risk management.
In our world, there are three ways to properly manage a portfolio’s risk – asset allocation, diversification, and knowing your investment timeframe.
Asset Allocation
In its simplest definition, asset allocation involves dividing your portfolio among different asset classes (e.g., stocks, bonds, real estate, and cash) based on your financial goals and risk tolerance. We do this with two goals:
- To help you achieve an optimal mix of assets that we believe will maximize your returns based on your risk tolerance and individual circumstances.
- To reduce overall portfolio volatility.
From a risk management perspective, we see this as the first step. Finding the right mix of assets for your situation can help provide enough stability during market fluctuations, with the intent of preventing emotional reactions that comes with stock market corrections. In our experience, a proper asset allocation doesn’t prevent negative returns, it generally keeps losses within the client’s risk tolerance.
Diversification
Not to be confused with asset allocation, diversification is about minimizing concentration risk by holding a mix of assets within the major asset classes. By holding a mix of assets, you reduce exposure to any single investment’s performance. It can also go beyond just your investment portfolio to include real estate, precious metals, and even collectibles for those with the knowledge and desire to own them.
For the equity portion of a portfolio, there are three ways to diversify:
- Allocate across various sectors, industries, and geographic regions: You want to have a broad-based portfolio that is more than just one sector, one index, or one country.
- Avoid individual position concentration: In our experience, this can happen in two situations. First, with an individual equity position that has been owned for many decades and has grown to be a large percentage of one’s assets or through ownership of one’s employer stock through either an Employee Stock Options Plan (ESOP) or executive compensation.
Rebalance periodically to maintain diversification: we do not believe you can just set it and forget it. Rebalancing should occur on either a pre-determined schedule (the beginning of the year for example) or when asset classes get outside of pre-determined parameters ( for example, plus or minus 5% of your asset allocation plan).
Know Your Investment Timeframe
It is very easy to have a long-term perspective on your investment portfolio when markets are doing well. When a bear market hits, however, keeping that perspective can become a challenge. Some investors make changes to their long-term strategy in challenging times, waiting to “get back in the market” when investing “feels better.” In our experience, this is a strategy that leads to selling low and buying high and sub-par investment returns.
We believe that successful wealth accumulation hinges on a steadfast commitment to a well-thought-out strategy over an extended horizon. Here are key reasons why a long-term perspective is crucial:
- Compounding Effect: Time is the investor’s ally. Compound interest and returns magnify over years, especially in equities. By staying invested, you allow your capital to grow exponentially.
- Reduced Emotional Reactivity: Short-term market fluctuations can evoke emotional responses—fear, greed, or panic. A long-term view helps mitigate impulsive decisions driven by transient market noise.
- Risk Mitigation: Over extended periods, asset classes tend to revert to their historical mean. Diversification across stocks, bonds, and other assets cushions against extreme volatility.
- Avoid Market Timing: Predicting market peaks and troughs is notoriously challenging. Investors who try to time the market often miss out on significant gains. A long-term approach minimizes this risk.
Alignment with Goals: Whether it’s retirement planning, funding education, or legacy building, long-term investing aligns with life goals. It provides the necessary runway for achieving those objectives.
Final Thoughts
Humans are emotional creatures. As related to investments, these emotions can easily get the best of us if we let them. In the best of times, we can get greedy and expect more from our investments than may be reasonable. In the worst of times, we can let fear get the best of us. The three keys to defeating these emotions are proper asset allocation, diversification, and understanding your investment horizon.
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On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
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.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.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 makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
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.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
The CRB (Commodity Research Bureau) Index measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodities trades.
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.
U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. The index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
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.
Robert I. Cahill, Partner Rob.Cahill@wfafinet.
Jonathan D. Soden, Managing Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Senior Account Administrator Jay.Knight@wfafinet.com