“’If I had an hour to solve a problem, I’d spend 55 minutes thinking about the problem and 5 minutes thinking about solutions.” Albert Einstein
The quote above is apropos for today’s everchanging investing world in which we receive an overload of information that comes to us faster than we perhaps need or want. But what doesn’t change, in our view, is that there are certain fundamentals required to be successful in our financial lives. Two of the most critical are discipline and diversification.
Below, we will review some historical performance data and look at some examples of why it is important to stay invested, stay diversified, and have discipline during periods of market volatility or underperformance.
What Happened During the Third Quarter of 2019?
What a difference a year makes.
A year ago, we were in the midst of a stock market rout. Recall that the S&P 500 fell 13.5% in the fourth quarter of 2018, as the Fed was still considering rate increases and the trade war with China was just beginning. When nearly everyone was convinced the stock market was in a new bear market heading into 2019, the S&P 500 staged a remarkable comeback this year, with a year-to-date gain of 20.6% through 9/30. Meanwhile the Fed decided that, after spending most of 2018 increasing interest rates, to do an about-face and has reduced rates, making for a great buying opportunity in bonds as well over the last year.
During the third quarter of 2019, U.S. large-cap stocks (as represented by the S&P 500) were flattish with a 1.7% gain. Smaller-cap stocks lagged, as the Russell 2000 Index posted a loss of 2.5% during the third quarter, though is still up 14.1% year-to-date. After lagging for much of the year on a relative basis, small Value equities (represented by the Russell 2000 Value Index), were up 5.13% in September, and emerging markets (represented by the MSCI Emerging Markets Index) gained 1.94%.
International stocks in developed economies, as represented by the MSCI EAFE Index, showed a slight loss of 1% for the third quarter but are up 13.4% year-to-date. Meanwhile, stocks in emerging markets (MSCI EM Emerging Markets Index) declined 4.1% during the third quarter, as the U.S. dollar has remained stronger than expected despite somewhat lower rates due to recent Fed rate cuts.
Meanwhile, bonds as represented by the Barclays U.S. Aggregate Index, have returned 8.5% in total return this year and added to 2.3% their gains in the third quarter – not too shabby.
Data Ending 9/30/2019 (not annualized if less than 1 year)
|MSCI ACWI (All Country World)
|S&P 500 (U.S. Large Cap)
|Russell 2000 (U.S. Small Cap)
|MSCI EAFE (International Developed)
|MSCI EM Emerging Markets (International Emerging)
|Fixed Income Indices
|FTSE World Government Bond Hedged (Global Bonds)
|Barclays U.S. Aggregate (U.S. Investment Grade Bonds)
|Barclays Municipal Bond 5Y (4 – 6) (Municipal Bonds)
|Barclays U.S. Corporate High Yield (U.S. High Yield)
|S&P Developed REIT (Global Real Estate)
|HFRI FOF: Conservative Index (Diversifiers)
Source: Zephyr Analytics & Morningstar
The Benefits of Owning Bonds in an Investment Portfolio
Let’s take a deeper dive on the bond market specifically, because it is a perfect case study on why you should not try to time your investments.
We could write a novel about how many times market pundits have opined about the “death of bonds” and bond bubbles over the years. As Mark Twain might have said, reports of the bond market’s death have been greatly exaggerated so far. Like any asset, bond prices will go up and down over periods of time, and we won’t pretend to know when the next downturn in bonds will hit. However, we do know that:
- There have been only three negative years for the U.S. Aggregate Index since 1976. 
- In 16 of the 44 years since 1976, the U.S. Aggregate Index has had a return greater than 8.5%. If we stopped this year now, 2019 would likely add to this count.
Surely there will be market cycles and periods where interest rates go up and bond prices drop. The last 18 months of financial market performance have clearly shown that there can be tremendous swings. But over longer periods of time, bonds have not only produced solid returns but importantly have shown relative stability and steadiness that also offer regular income – all of which can help manage risk in an overall diversified portfolio.
Source: Matrix Book 2019, Dimensional Fund Advisors
At Modera Wealth Management, we also look to further diversify our clients’ bond portfolio risk by evaluating and managing a variety of fixed-income investment sectors, including:
U.S. Treasuries, where investment principal is guaranteed by the U.S. government
Non-U.S. bonds, which helps to reduce country-specific risks
Short-term Treasury Inflation-Protected Securities (TIPS), which provide some protection against inflation
Convertible securities, which provide income plus potential equity-like upside
Municipal bonds, which can offer federal and state tax advantages
Corporate bonds, which are tied to the financial prospects of individual companies
High-yield bonds, which generate higher levels of income and tend to be more correlated with stocks
The Benefits of International Investing
To be balanced, let’s also examine the performance of international equities. The headlines are all about tariffs, trade wars, global growth, Brexit, and other issues that seem to never end. It’s enough to get one to ask, why am I invested overseas?
If we compare performance of the MSCI EAFE Index vs. the S&P 500 over the prior 5- and 10-year time frames, stocks of more developed countries have struggled to keep pace with their counterparts in the U.S. But if we were to look at annual data prior to the financial crisis, we would also see longer periods of time where this comparison flipped and international significantly outperformed U.S. stocks. For example, in the 2000s, international stocks significantly outperformed U.S. stocks and were even greater outperformers vs. the U.S. in the 1980s.
Source: Seeking Alpha, https://seekingalpha.com/article/4254124-summarizing-case-international-stocks
In the 49 years from 1970-2018, the S&P 500 outperformed the MSCI World EX US Index (a broad international stock index) in 25 of those years, and underperformed in 24 years – so just about an even split. When you extend the periods to 5-year annualized relative returns you can see that there are long stretches when international equities significantly outperform such as the 1970s to early 1990s and again from the early 2000s to about 2010.
Source: Matrix Book 2019, Dimensional Fund Advisors
Over the 40 five-year annualized periods between 1970 and 2018, the S&P 500 has outperformed in only 21 periods, again just about a 50/50 split. In fact, no matter whether the annualized periods are three-, five- or 10-year periods, the number of times that US equities or international equities outperform is roughly an even split.
Again, it is hard to know when a multi-year period of relative outperformance trend will begin and end, and when to get in and get out; but historically, a strategy that invests across both U.S. and international equities should remove the “timing” decision and allows one to achieve diversification benefits relative to simply holding just one asset class.
What Should You Do? Sharpen Your Axe
“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.”
That quote is attributed to Abraham Lincoln, and just as Einstein spent a lot of time focusing on the objectives and being patient, so too did Lincoln. There is a lot of information and headlines that scream, what to do now, what to do tomorrow, what should have been done yesterday. At Modera, the themes and values we stand by are as good today as they were many years ago and we hope they will stand the test of time for many years to come. We always tell our clients to stay the course through market volatility — and we’ve seen a lot more of it over the last 18 months, in both stocks and bonds. But this is tough to do, especially if you get caught up in the emotions of the moment. The headlines of today will be but memories in a few months.
We are patient and remain focused and disciplined while offering diversified portfolios to our clients with a longer-term outlook. It is what we do. That means that we sometimes will buy and hold investments that are out-of-favor and sell other investments that are in vogue. Our philosophy is that not all our investments may provide clients with instant gratification, but we firmly believe that over time this strategy can make their investment portfolios healthier, more durable, and importantly help them achieve their own personal financial goals.
We believe this thoughtful process has held our clients in good stead over time. It is why our clients come to us to help guide them through the market ups and downs, and ultimately why they stay with us for many years.
 Source: Matrix Book 2019 Dimensional Fund Advisors
 Source: Zephyr Analytics & Matrix Book 2019 Dimensional Fund Advisors
Modera Wealth Management, LLC (“Modera”) is an SEC registered investment adviser with places of business in Massachusetts, New Jersey, Georgia, North Carolina and Florida. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements.
For additional information about Modera, including its registration status, fees and services and/or a copy of our Form ADV Disclosure Brochure, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). A full description of the firm’s business operations and service offerings is contained in our Disclosure Brochure which appears as Part 2A of Form ADV. Please read the Disclosure Brochure carefully before you invest or send money.
This quarterly commentary is limited to the dissemination of general information pertaining to our investment advisory services and financial planning services and general economic and market conditions that is not suitable for everyone. The information contained herein should not be construed as personalized investment, financial planning, legal, tax or accounting advice. For legal, tax and accounting related matters, we recommend that you seek the advice of a qualified attorney or accountant.
The returns shown in table 1 are annualized returns, except for periods less than one year, for selected asset classes as represented by benchmark indices. Investors cannot invest directly in an index. Unmanaged indices do not reflect management fees or transaction costs associated with some investments. Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed herein will come to pass. This document contains forward-looking statements that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. Readers are cautioned not to place undue reliance on forward looking statements, which speak only as of the date of this document.
Investing in the equity and other markets involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered a solicitation to buy or sell any security or to engage in a particular investment or financial planning strategy. Individual client asset allocations and investment strategies differ based on varying degrees of diversification and other factors. Diversification does not guarantee a profit or guarantee against a loss. Not all asset classes or funds discussed herein are held in all Modera client accounts, and the asset classes and indices discussed in this quarterly letter were selected for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell any securities. The performance of Modera client accounts may differ depending upon actual composition.
S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2018, all rights reserved. Bloomberg Barclays data provided by Bloomberg.