The S&P 500 Index is down over 12% from its high last May, which qualifies as a market correction but not a bear market. In fact, it’s been quite a while since we experienced our last bear, although it may not feel that way. From April to October of 2011, the stock market declined by 19.39% on a closing basis. While experts can debate whether this meets the definition of a bear market (which are typically defined as 20% declines), those who remember it will recall how scary it was. By the time the market bottomed in October, many were recalling the 2007–2009 bear market, which was gut wrenching for everyone. During that excruciating market decline, the S&P 500 Index fell by 55% and the economy tumbled into a deep recession. It is only in hindsight that we can see that both the market bottom in 2009 and the October low in 2011 marked important market bottoms. Since October of 2011, the S&P 500 Index rallied 94% to its eventual high set in May of last year.
The second quarter started in somewhat choppy fashion as small cap and other high flying momentum stocks continued to face pressure as investors decided to shed stocks with swollen valuation multiples. The major averages fared better than their risky counterparts, and after a brief dip stocks began their ascent towards record breaking highs on the back on improving economic data, decent earnings growth, and continuing liquidity support from global central banks.
Meanwhile commodity markets appeared to work off some of their overbought readings from earlier in the year as they treaded mostly sideways during the quarter. Within fixed income, the bond market also fared well as investors continued to flock towards anything with a yield, foreign bond markets bubbled, and a number of technical factors came together to keep bond investors satisfied despite meager nominal yields.
NOTE: There is a 100% probability that bull markets will be followed by bear markets. This article is not a forecast about imminent market behavior. For our latest views on markets, clients should read our market review. Financial fire drills are all about testing your emotional response to a bear market, which you should be doing all the time. (And it’s not a bad idea to check your emotional reaction to bull markets, as well.)
When I was a kid, my family lived in a two-story colonial in South Jersey. Once each year, to the great excitement of all concerned, my parents had my brother, sister, and me conduct a fire drill. We got to climb out of our bedroom window onto the roof of the garage, and then down from there.
Our house never suffered a serious fire, and we never had to make a rooftop escape, but my parents were still glad that we’d practiced what we had to do, just in case. It was a very good idea.
If you are looking for a movie about power, money, sex, drugs, yachts, Lamborghinis, high-pressure sales tactics, stock manipulation, sex, and drugs (did I mention sex and drugs?) then go see the new Martin Scorsese movie, The Wolf of Wall Street, starring Leonardo DiCaprio. The film is based on the memoirs of Jordan Belfort, the founder of the brokerage firm Stratton Oakmont, which functioned as a boiler room selling penny stocks in the 1990s. I don’t want to give away the ending, but I will say that if you enjoy watching unimaginable amounts of corruption and debauchery, you are going to love it.
All of which gets me thinking about the admittedly boring world of our Pinnacle investment analysts.
Actively managing a portfolio requires buying and selling securities with the goal of managing risk and outperforming passive benchmark portfolios. Clients are correct to question the number of trades that are being made in their portfolio in pursuit of this objective. After all, one trade can generate several trade acknowledgments from our custodians, and each trade acknowledgement shows the brokerage commission charged for each transaction. Clearly the cost of trading has a negative impact on total portfolio return. As we approach year-end and Pinnacle’s investment team continues to generate commissionable transactions in our managed accounts, it might be helpful to analyze the cost of brokerage commissions relative to our ability to implement our active management strategy.
With less than two months to go in the year, the markets have returned a remarkable 23% on the S&P 500 index. Our portfolios are diversified, so we haven’t gained that much, but many policies are in double-digit territory (which represent significant gains in less than a year). With healthy returns already booked, one has to question whether investors will want to cash out and go the beach. I admit that a trip to the Bahamas sounds great right about now.
In a recent “Your Money” column in the New York Times, John Wasik did a great job of delivering the status quo message about portfolio expenses. He reminds us that John C. Bogle, Founder of the Vanguard Group, and many others, have performed studies that demonstrated that active managers cannot beat a passive index because of the fees charged in actively managed funds. He reminds us that these consist not only of the well-known and often discussed fees in a fund’s expense ratio, but also include ‘hidden’ fees like the cost of managers who leave too much money in cash (which does not earn market returns), and fund transaction costs. The article goes on to mention a recent paper by William Sharpe, the Nobel Prize winner this year in Economics, who compared the expense ratio of Vanguard’s Total Stock Market Index Fund to a more expensive actively managed fund, and found that the costs of active management were $2,000 for a $10,000 investment over ten years.
With the end of the government shutdown and the lifting of the debt ceiling, it’s time to review how we’ve positioned Pinnacle’s portfolios. First, our stance has been that the political impasse was mostly noise — that’s why we didn’t pull volatility down over the past few weeks. Washington’s politicians waited until the last minute, hoping to force some policy concessions, but had to acknowledge the practical reality that making a deal was better than the alternative.