The third quarter of 2020 continued the equity markets’ general upward from the market lows we saw in March. As mentioned in the previous newsletter, many investors have experienced uneasiness as to whether these gains would hold. Since numerous reasons abounded on the bearish side of the ledger, we identified three reasons at the time that may have explained the market’s resilience this year.
Fast forward to today, in answering the ever-prescient question of, “Where will the market go from here”, I borrow an old quip from Warren Buffett: “It will fluctuate”. Before discussing an approach below regarding how to invest in a time of increased risk and uncertainty, the approximate third quarter returns of major indices were as follows:
· S&P 500 +9%
· Russell 2000 (Small Cap US Stocks) +5%
· MSCI ACWI Ex-US (International Stocks) +6.5%
· Barclays Aggregate Bond +0.5%
Turning to risk and uncertainty, there are two distinct types of competing financial risks, in my opinion. The first is volatility risk, which is the day-to-day gyration of the markets. Right now, volatility risk receives most of the attention and energy of investors.
The second type of risk currently receives less attention. However, it may be more relevant to the long-term investor. This risk is the inability to meet long-term goals or satisfy expected standard of living conditions in retirement, due to inadequate returns of capital. Warren Buffett defines risk in this way -- as the gain or loss of purchasing power over time. He elaborates:
“Volatility is far from synonymous with risk… If the investor…fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents… [but over the long term] a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.”
This type of risk may become more apparent in years ahead, as investors weigh the attractiveness of buying a 10-year US treasury bond at a 0.70% yield, while the Federal Reserve has indicated targeting inflation above 2%.
Thus, how do we as investors balance the two risks: short-term volatility versus maintaining long-term purchasing power? One approach may be that an investor in the decumulation phase of their life might spend more energy on the former (short-term volatility), while an investor in the accumulation phase of their life might spend more energy on the latter (long-term purchasing power).
These are discussions we very much value having with you. We encourage you to call, email, or use our online portal at any time if you want to check-in on your journey. We are happy to help you with any questions you may have.
Daniel Schoenecker, CFA, MBA
Chief Financial Officer
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The MSCI ACWX Index is a float-adjusted market capitalization index designed to track the investment results of an index composed of large and mid-capitalization non-U.S. equities. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index . The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.