“Stay humble or the market will do it for you.” – Todd Harrison
After a number of solid months for the financial markets, August turned into a reality check for the most bullish market participants. Every index we follow here, with the exception of the US Dollar index, posted losses for the month. The market indexes that are considered more speculative – Emerging Markets, Small Caps suffered larger losses than US Large Cap indexes (Dow Industrials and S&P500). The Aggregate Bond Index and CRB Commodities Index posted small losses.
All data as of 08/31/2023, 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.]
Apparently, the stock market doesn’t just move higher. The month of August has made that abundantly clear. After what many would consider surprisingly solid stock market index returns through July. We found nothing surprising about the suddenly soft stock market. As we mentioned in our August Commentary, we believed that the market was getting too complacent and that August and September are historically weak. Unfortunately, we were correct in that assessment.
Taking a step back, things are not all that bad. After bottoming in price around the middle of the month, the S&P500 turned higher, closing the month out with a relatively small loss and above both the 200-day and 50-day moving averages. We believe this is significant because in technical analysis many (including Magellan Financial) view this as bullish for the stock market. A market below the 50-day moving average would be considered bearish and below the 200-day moving average long-term bearish.
Yet we remain cautious for two reasons – seasonality and we’ve seen this before. In 2019 (Chart #2) there was similar price action during the month of August to what we just experienced last month. After some sideways to slightly higher levels in the S&P500 the index tested the August 2019 lows before moving higher into the end of the year. Of course past performance is not a guarantee of future results.
Chart #1: www.stockcharts.com Data 12/12/22 – 08/31/23 as of 08/01/23. An index is not managed and not available for direct investment. MA 50 = 50 day moving average MA 200= 200 day moving average. Past performance is not a guarantee of future results.
Chart #2: www.stockcharts.com Data 01/01/19 – 12/31/19 as of 08/01/23. An index is not managed and not available for direct investment. MA 50 = 50 day moving average MA 200= 200 day moving average. Past performance is not a guarantee of future results.
Over in the bond markets we are seeing what we believe has the potential to be a top in the 10-year Treasury yield. In our opinion, this is an important development because the 10-year Treasury yield is an important economic indicator that serves as a benchmark for many other financial markets, including the US stock market and mortgage rates.
The yield on the 10-year Treasury bond is closely watched by investors as it reflects broader investor confidence. When the yield on the 10-year Treasury bond rises, it indicates that investors are moving away from low-risk investments such as Treasury bonds and towards higher-risk, higher potential-reward investments. This can lead to an increase in mortgage rates and other borrowing costs. Conversely, when the yield on the 10-year Treasury bond falls, it suggests that investors are seeking safer investments, which can lead to a decrease in mortgage rates and other borrowing costs.
In summary, the 10-year Treasury yield is something we will be closely monitoring as it is an important indicator of investor confidence and has historically impacted other financial markets.
Chart #3: www.stockcharts.com Data 08/01/23 – 07/31/23 as of 08/01/23. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results.
Cash as an Investment?
After years of cash savings paying very little, the return of yield in 2023 has made cash and cash equivalents popular among investors. With money markets and bank-issued CDs paying more than 5%, we can understand the attractiveness. Getting a set yield and liquidity cash provides can feel quite compelling, especially after a year like 2022.
But, while holding cash as a long-term investment may feel stable, is this something you should consider?
Here’s what we know: over the past 20 years, cash returns substantially lagged other major asset class returns. As a result, holding excessive cash within an investment portfolio would potentially have detrimental effects on long-term returns. While cash is often viewed as a safe haven due to its stability and liquidity, it generally yields lower returns compared to other asset classes over extended periods. In the context of inflation, the purchasing power of cash erodes over time, leading to a reduction in real value. Additionally, during periods of economic growth, the opportunity cost of holding cash becomes evident as it misses out on potential gains that can be accrued through investments.
Consequently, an over-allocation to cash can hinder the portfolio’s ability to generate meaningful returns and may hinder the achievement of financial goals.
Fear of the Stock Market?
The other issue that has made cash as a desirable investment for some investors is a fear of the stock market. More specifically, the fear of the short-term volatility of returns, which we understand to some degree. It is never comfortable to see your investments worth less than they were last month or last year. Yet, short-term stock market returns tend to have little impact on your long-term investment success for several reasons:
- Short-term returns are often volatile and unpredictable: The stock market is subject to many external factors such as economic conditions, political events, and global trends that can cause sudden fluctuations in stock prices. These short-term movements are difficult to predict and can result in significant losses if an investor makes hasty decisions based on short-term returns.
- A long-term investment strategy focuses on the underlying fundamentals of the economy: An investment in the stock market is an investment in the growth of the US economy. When you invest in stocks, you are essentially buying a small piece of ownership in a company. If the company grows and becomes more profitable, the value of your investment increases. Inversely, a company can lose in value as can the investment. The stock market is made up of many companies, and if these companies grow and become more profitable, the overall economy grows as well.
- A long-term investment strategy allows an investor to benefit from the power of compounding: In our experience, this is a hard concept to understand for many people. Compounding is the process in which an asset’s earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. This growth occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods.
- This compounding effect can result in long-term returns: In summary, focusing on short-term stock market returns is not important to your long-term investment success. Instead, a focus on the underlying fundamentals of a company and a long-term investment strategy can help you achieve your financial goals.
Final Thoughts
As compelling as cash as an investment is at this moment may appear, we do not believe that it is a viable investment solution for anything other than the shortest of investment goals. While we understand the temptation to hold excess cash as a “safety measure,” historical returns tell us it really isn’t the best approach. The implications of an imbalanced allocation – particularly an overemphasis on cash – can significantly impact long-term returns.
We believe a better approach to achieving sustainable long-term returns, while seeking to manage risk, is a balanced portfolio that aligns with your investment objectives. What this specifically looks like is a result of accounting for personal risk tolerance, financial goals, and other circumstances that vary from investor to investor. It can and should change over time as your personal situation changes. How we invest as 30-somthings with two kids and a dog is different than the pre-retirees who want to travel the world and spoil the grandkids.
So, yes, cash should play a role in your investment strategy, it just shouldn’t be your investment strategy.
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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.
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