Quarter Review Banner Q2 2017

The 2nd Quarter of 2017 in Review

Quarter Review Banner Q2 2017

Markets continued their climb during the 2nd Quarter of 2017 with most of the gains coming from outside of the United States. In the U.S., home sales reached their highest levels since they peaked before the 2008 Financial Crisis, job openings hit hew highs, the unemployment level fell to a 16-year low, and the NASDAQ reached record levels.

Outside our borders, housing prices in the Eurozone reached pre-2008 crisis levels, Eurozone confidence hit a post crisis high, the IMF upgraded the United Kingdom’s growth forecast as Brexit fears eased, and major indices in the Developed and Emerging Markets around the world continued to lead their U.S. counterpart.

What may be noticeable to investors is the underperformance of U.S. Small-Cap Value stocks compared to other indices around the world. From January 1 through June 30th of this year, U.S. small-cap value stocks have been the worst performing asset class, delivering a -0.37% return. Investors may be tempted to think that this is some sort of “trend” or “reversion to the mean” given their superior performance in 2016.

We want to remind investors that a “trend” or “reversion to the mean” is implying that there is a knowable and quantifiable serial correlation in returns. In other words, “reversion to the mean” implies that we can predict future market movements based on what has occurred in the past. To assume that this is occurring would be a mistake. While it is ingrained in our DNA to look for patterns in randomly occurring events, it doesn’t necessarily mean that it accurately depicts reality. Historically, prices have shown short-term momentum in markets around the world, but not a reliable “trend” in which we can accurately predict the future based on past price movements. This goes back to Eugene Fama’s 1965 paper entitled The Behavior of Stock-Market Prices in which he eloquently stated:

“the main conclusion will be that the data seem to present consistent strong support for the model [random walk].  This implies, of course, that chart reading, though perhaps an interesting pastime, is of no real value to the stock market investor. This is an extreme statement and the chart reader is certainly free to take exception. We suggest, however, that since the empirical evidence produced by this and other studies in support of the random-walk model is now so voluminous, the counterarguments of the chart reader will be completely lacking in force if they are not equally supported by empirical work.”

Because market movements are unpredictable, investors should look to this short-term performance in U.S. Small Cap Value stocks merely as a random outcome and try not to succumb to attempting to predict the future.

Domestic Equities

For the different size and styles of domestic equities, the quarterly returns ranged from -0.62% for small cap value stocks to 4.69%% for large cap growth stocks. In general, large cap stocks beat small cap stocks across both growth and value investment styles. Similarly, growth outperformed value across all size groups. Year-to-date, large cap-growth stocks have been the top performers (14.75%) while small-cap value stocks have been the worst performers (-0.37%).

For the blend of domestic equity indexes used in the IFA Index Portfolios, the quarterly return was 1.08% for Q2 and 3.32% year-to-date. This underperformed the US market as a whole (as measured by the Russell 3000 Index), which delivered 3.02% in Q2 and 8.76% year-to-date.

International (Developed) Equities

On the international front, equities from our developed counterparts outside of the US had another strong quarter. In Q2, results ranged from 4.26% for international value stocks to 7.37% for international small cap stocks. Year-to-date, international stocks have delivered strong results ranging from 10.43% (international value stocks) to 16.39% (international small cap stocks).

Returns by country in Q2 ranged from -1.43% (Australia) to 18.39% (Austria). Top performing countries included Austria (18.39%), Denmark (15.14%), Finland (13.28%), New Zealand (11.70%), and France (9.54%). The worst performing countries included Australia (-1.43%), Canada (0.48%), Norway (3.15%), Belgium (4.79%), and Singapore (4.88%).

For the blend of international indexes used in the IFA Index Portfolios, the return was 6.11% in Q2 and 13.80% year-to-date. This has outperformed the international developed market as a whole (as measured by the MSCI World ex US Index), which delivered a return of 5.63% in Q2 and 12.44% year-to-date.

Emerging Markets

The Emerging Markets continued their strong performance during Q2 of 2017. For Q2, the returns ranged from 2.28% for emerging markets small cap stocks to 5.92% for emerging markets large cap stocks. Year-to-date, returns have ranged from 17.42% (emerging markets value stocks) to 19.71% (emerging markets large cap stocks).

Returns by country in Q2 ranged from -11.23% (Qatar) to 34.11% (Greece). Top performing countries included Greece (34.11%), Hungary (18.88%), Turkey (18.88%), Poland (13.46%), and South Korea (9.75%). Worst performing countries included Qatar (-11.23%), Russia (-9.87%), Brazil (-6.37%), Chile (-2.28%), and the United Arab Emirates (1.00%).

For the blend of emerging markets indexes used in the IFA Index Portfolios, the return for Q2 was 3.54% and 18.12% year-to-date. Our blend underperformed the Emerging Markets as a whole during Q2 but has outperformed year-to-date. The Emerging Markets as a whole (as measured by the MSCI Emerging Markets Index) delivered a return of 6.27% in Q2 and 17.71% year-to-date.

Real Estate

Global real estate securities delivered positive return of 1.79% in Q2.

Fixed Income

Interest rates in US income markets flattened during Q2 with longer maturities decreasing more than shorter and intermediate term maturities. 5-year US Treasuries decreased by 4 basis points (1.89%) while 30-Year US Treasuries experienced a 18 basis point decrease (2.84%).

For Q2, the four fixed income funds used by IFA delivered positive returns ranging from 0.28% for 1-year bonds to 1.80% for 5-year global bonds.

For the blend of fixed income used in the IFA Index Portfolios, the return was 0.43% for Q2 and 0.90% year-to-date.

IFA Index Portfolios

Putting it all together, the returns of the IFA Index Portfolios are shown below net of two quarter’s worth of IFA’s maximum annual 0.90% advisory fee.

What investors need to remember is that there will always be periods in which their IFA Index Portfolios will underperform in the short-term. This is the very nature of taking risk. Given the recent underperformance in U.S. Small Cap Value stocks compared to U.S. Large Cap Growth stocks, many investors may be wary about their asset allocation. The chart below shows rolling period return of the IFA U.S. Small Cap Value Index versus the IFA U.S. Large Cap Growth Index. Over any given month, the odds of U.S. Large Cap Growth stocks outperforming are slightly less than a coin flip. But once we expand our view to longer time horizons, you can see that a disciplined approach yields favorable results for the globally diversified investor.

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 2nd Quarter 2017 IFA Client Performance Monitoring Report.

We recently created the IFA Index Funds Investing Kit that includes a copy of Index Funds: A 12-Step Recovery for Active Investors book, the documentary film of the same title, as well as The Random Walker, which simulates market outcomes based on fair prices right before your very eyes. You can find both through Amazon.