2019 Q4 Review

Tuesday, January 28, 2020 1,097 views

An easing of trade tensions between the U.S. and China along with signs of improved eurozone economic data helped stocks around the world produce strong gains in 2019's fourth quarter.  

Returns were hardly uniform, however. While large-cap U.S. equities indexes outperformed those of international developed markets, both wound up lagging IFA's emerging markets benchmarks. Domestic value stocks underperformed growth-styled equities in Q4. In bonds, funds benchmarked to the shorter-end of the investment-grade yield curve fared best in the quarter. 

The swings came amid headlines of a trade deal being cut by negotiators in Washington and Beijing. The U.S. Federal Reserve also helped to calm markets by issuing a statement after lowering short-term interest rates indicating economic pressures for more such moves were waning. Adding to rising sentiment was increased consumer spending in Germany and an uptick in core machinery orders in Japan. A landslide general election victory by the Conservative Party eased near-term geopolitical concerns in the U.K.

So, what does all of this mean? In reviewing Q4 equity and fixed-income results as tracked by IFA Index Portfolios, it's probably worth noting that investors would be well-advised to assume that the expected return for a consistent level of investment risk remains essentially constant over time. 

Of course, investment risk requires that there are surprises and sometimes significant differences between the expected return and realized returns. (In fact, our research shows that realized monthly returns wind up looking something like a bell curve with the expected return falling in the center when the number of months, or sample sizes, are very large.)

For example, if the current prices of securities in a diversified portfolio -- which are fair prices because they were set by millions of willing buyers transacting with millions of willing sellers in a free market -- declined by 1.75% today, investors can assume that the uncertainty of the expected return of those securities in total increased by 1.75%. That increased uncertainty was created by negative news and information that increased the uncertainty of the expected return of those securities. This free market price discovery process keeps the expected return for the portfolio of securities essentially the same regardless of the news and information. It is also important to be aware of the randomness of future news resulting in the randomness and unpredictability of future prices and the resulting returns.

To provide a framework for how markets work, we've created the Hebner Model which is shown below. It's designed to illustrate what happens to an essentially constant risk exposure and the risk-appropriate monthly expected return for a given index portfolio set at the fulcrum of a teeter-totter. The intersection of good and bad news results in a level of uncertainty on the left side and the price that millions of buyers and sellers agree to is on the right side. The price moves inversely proportional to the uncertainty so that the expected return is held essentially constant. But it also illustrates the range of outcomes of realized returns compared to the expected return over long periods of time. 

 

Domestic Equities

After a rather volatile third quarter, all IFA U.S. stock indexes rebounded in the final three months of 2019. The returns in Q4 were robust with IFA indexes ranging from 9.91% for domestic large-cap growth equities to 8.46% for small-cap blended stocks. The turnaround was particularly notable across small caps, given negative returns in growth and value in the previous quarter. For the year, all six IFA domestic indexes reviewed below ended the year with double-digit gains. 

 

International (Developed) Equities

IFA index returns from developed countries that are outside the United States all rebounded in Q4 from a sharp drop in the previous three month period. In Q4, results ranged from a gain of 12.25% for blended small-cap international equities to a rise of 7.82% for international large-cap value stocks. In 2019,  returns ranged from 15.67% for international value equities to 24.20% in foreign small caps. 

 

Emerging Markets Equities

Emerging Markets also had a strong close to 2019. For Q4, emerging markets returns ranged from a gain of 10.77% for emerging markets blended large-cap equities to a rise of 9.69% for emerging markets blended small-cap stocks. By comparison, Q3 returns landed in negative territory. For a full calendar year, the blended large-cap IFA index led the way by returning 16.03% in 2019. 

 

Real Estate Equities

Global real estate was another positive performer in 2019. In the fourth quarter, IFA's Global REIT Index returned 1.61%. Although slower than the previous quarter, this part of the market finished the year with a solid 26.40% gain. 

 

Fixed-Income

In the first quarter, the 30-year U.S. Treasury rate increased by 28 basis points while the five-year U.S. Treasury rate decreased by 18 basis points.

For Q4, the four bond benchmarks reviewed by IFA delivered returns ranging from 0.52% for the IFA Two-Year Global Fixed Income Index to 0.15% for the IFA Five-Year Global Fixed Income Index. If interest rates have risen, the price of existing bonds can be expected to decrease -- so that new buyers receive the same current yield as that available from newly issued bonds at the higher rate with similar maturities and risk levels.

 

IFA Index Portfolios

All of the returns of the IFA Index Portfolios shown below are net of the maximum annual 0.90% advisory fee through Dec. 31, 2019. Reflecting strong performances across indexes in both equity and fixed-income categories, each produced a robust uptick in Q4.

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 4thQuarter 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.


Performance results for actual clients that invested in accordance with the IFA Index Portfolio Models will vary from the backtested performance due to the use of funds for implementation that differ from those in the index data, market conditions, investments cash flows, mutual fund allocations, changing index allocations over time, frequency and precision of rebalancing, not following IFA's advice, retention of previously held securities, tax loss harvesting and glide path strategies, cash balances, lower advisory fees, varying custodian fees, and/or the timing of fee deductions.

This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ 

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