Quarter Reivew Q1 2019

2019 Q1 Market Review

Quarter Reivew Q1 2019

In the opening three months of 2019, U.S. and international equity indexes produced a dramatic about-face. Across every major asset-class reviewed by IFA, market conditions created a perfect storm to whipsaw short-minded traders. 

The blue chip S&P 500 returned 13.65% in the first quarter, helping to offset 2018's fourth quarter loss of 13.53%. That mirrored the IFA Large Company Index's 13.63% rise in Q1 as compared to its -13.53% fall in the previous three months. 

The swift and severe change in market conditions shouldn't come as a shock to IFA.com readers. We know from Nobel Laureate William Sharpe's earliest work in developing the Capital Asset Pricing Model that stocks and bonds courting greater market risk and higher volatility should result in higher expected returns. 

Seminal research by another Nobel Laureate, Eugene Fama, shows us how efficiently free markets price securities. As he's observed, this means that at any point in time "prices reflect all available information so that ... it is basically impossible to beat the market." 

Further academic evidence of the dangers in trying to outguess markets comes from studies undertaken by Paul Samuelson, who in 1970 became the first American to win a Nobel Prize in economics. His research found that pricing mechanisms in a free-market system stand as the single most effective way to estimate a stock's true value. Interestingly, he also concluded that since future news and stock prices are unpredicatable, price changes act in a largely random fashion.

As a result, Samuelson observed that “investing should be dull, like watching paint dry or grass grow." For traders who want to gamble, he suggested, "take $800 and go to Las Vegas." After all, he warned: "It is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office.” 

With such top-drawer academic research as a backdrop, we present our latest Q1 review below. But let's keep this in perspective. "Statisticians require data from periods of at least 30 years to minimize the sampling error of short-term data and to provide a more reliable estimate of expected returns and risk," wrote IFA President Mark Hebner in his book examining the academic and scientific underpinnings of IFA's passive investment strategy.

Unfortunately, he added, "very few managers are able to provide 30 years of data to their clients." So given active management's proclivity to play shell games with fund performance by exposing their portfolios to the ill-effects of style drift and survivorship bias, we enourage you to take what follows with a healthy grain of salt. It's provided as fodder for more discussion with an IFA advisor, who can help you to balance any immediate market concerns with your longer-term wealth management goals. 

Domestic Equities

The plight of U.S. stocks in Q1 serve as a prime example of how quickly market conditions change. After a volatile end to 2018, all IFA domestic stock indexes strongly rebounded to start the new year. The returns in Q1 were indeed impressive, ranging from 19.53% for IFA's U.S. small-cap growth equities benchmark to 10.79% with its sister large-cap value index. As further evidence that investors need to take a step back before considering making any portfolio moves, IFA's domestic large-cap growth equities index produced a 16.90% return and IFA's small-cap blended index rose by 12.42%  after suffering double-digit declines in Q4 2018. 

Returns of IFA Domestic Equity Index -q1-2019

International (Developed) Equities

IFA index returns from developed countries that are outside the United States all rebounded in Q1 from a sharp drop in the previous quarter. In Q1, results ranged from a gain of 9.92% for blended small-cap international equities to a rise of 8.46% for international large-cap value stocks. That was quite a change-in-course sequentially. In Q4 2018, international small-cap value fell by 17.91% and international blended value stocks did just slightly worse, losing 14.63%. 

Return of IFA International Equity Indexes - Q1-2019

Emerging Markets Equities

Emerging Markets also had a very strong opening quarter of 2019. For Q1, emerging markets returns ranged from a gain of 8.80% for emerging markets blended small-cap equities to a rise of 7.15% for emerging markets large-cap value equities. By comparison, Q4 2018 returns ranged from -7.17% (emerging markets large-cap value equities) to -6.57% (emerging markets blended small-cap equities).  

Return of IFA Emerging Markets Equity Index-Q1-2019

Real Estate Equities

Global real estate was another shining example in Q1 of the broad benefits in taking a diversified approach to investing. In the quarter, IFA's Global REIT Index returned 15.20%. 

Returns of IFA Real Estate Index-q1-2019

Fixed-Income

In the first quarter, the 30-year U.S. Treasury rate decreased by 16 basis points while the five-year U.S. Treasury rate decreased by 26 basis points.

For Q1, the four bond funds used by IFA delivered returns ranging from 1.71% for the IFA Five-Year Global Fixed-Income Index to 0.77% for the IFA One-Year Short-Term Fixed-Income Index. If interest rates have risen, the price of existing bonds with a lower coupon rate decrease so that new buyers of the bonds can get the same total return (capital gains plus interest) as that available from newly issued bonds at the higher rate and at similar risk.

IFA Index Portfolios

The returns of the IFA Index Portfolios are shown below net of the maximum annual 0.90% advisory fee through March. 31, 2019. Reflecting strong performances across indexes in both equity and fixed-income categories, each produced a strong rebound in Q1. 

Returns of IFA Index Portfolios-q1-2019

Given the recent underperformance in U.S. value stocks as compared to growth stocks in both large and small companies, some IFA clients may be wary about their tilt toward small and value companies. The chart below shows monthly rolling period returns of the IFA U.S. Small Cap Value Index versus the IFA U.S. Large Cap Growth Index for the last 50 years.

Over rolling one-month periods, it has been a toss up between Large Cap Growth and Small Cap Value. But once we expand our view to longer time horizons, you can see that small value was the better index to own. 

Each quarter, IFA monitors the funds they recommend for clients and as part of that process, we’ve developed a rating system. Below is a link to our Performance Monitoring Report for client portfolios: IFA First Quarter 2019 IFA Client Performance Monitoring Report.

We've created the Investing Kit that includes a copy of "Index Funds: The 12-Step Recovery Program for Active Investors" book and documentary film based on the book, as well as the Galton Board, Stock Market Edition, which simulates the distribution of 600 monthly returns right before your very eyes. You can find the Investing Kit on Amazon.