Diversified portfolios generated solid returns in the first three months of the year as stocks rebounded strongly from the selloff in the fourth quarter of 2018. The main catalyst for the rebound was a reversal in policy by the Federal Reserve. As the first quarter unfolded, Fed Chairman Jerome Powell made it increasingly clear that the Fed did not expect to follow through with its previously planned interest rate increases. Bond market investors now believe the Fed’s next move will be to cut interest rates later this year. Stocks also benefited from positive developments in U.S. – China trade negotiations.
Within the U.S. market, gains were broad-based. The S&P 500 gained 13.7%, almost a mirror image of the 13.5% loss in the fourth quarter of 2018. Value stocks, as measured by the Russell 1000 Value Index gained 11.9% and small company stocks, as measured by the Russell 2000 Index, gained 14.6%. Growth stocks registered particularly strong returns as the S&P 500 technology stock sector gained nearly 20%.
Foreign stocks also rose strongly in the first quarter. The MSCI AC World ex U.S. Index generated a return of 10.3%. Here too, gains were broad-based as the major developed country and emerging country indices posted similar returns in the 10% range. Even the U.K. stock market, on the cusp of a potentially highly disruptive exit from the European Union, gained almost 12%.
Bonds also registered positive returns during the quarter. The Barclays Aggregate Bond Index returned 2.9% as yields across the U.S. Treasury yield curve declined about ¼ of 1%. Benign inflation data and moderating growth in the U.S. contributed to the decline in yields.
Technology and “new economy” stocks such as Amazon led the market higher in the first quarter after stumbling in last year’s fourth quarter. Returns of these mega tech stocks have been quite strong over the recent past. To illustrate, a portfolio containing equal investments in the five largest U.S. tech/new economy stocks (Apple, Microsoft, Amazon, Alphabet (Google) and Facebook), generated an annualized return of nearly 25%1 over the five years ending in March, more than twice the 10.9% return generated by the S&P 500 Index over the same period. These large tech stocks now dominate the list of the biggest stocks by market value in the U.S. to an extent not seen since the technology stock bubble of the late 1990s. The above-named stocks comprise five of the top six largest companies by value in the U.S. – Berkshire Hathaway (at #5) is the only non-tech company on this list. The value of these five tech companies combined tops $4 trillion, exceeding the stock markets of all but three of the world’s countries (U.S., Japan and China).
As Rob Arnott of Research Affiliates and John Authers of Bloomberg recently pointed out, buying the biggest stocks in the market has been a poor strategy in the past. Over the 38 years since 1980, a strategy of investing in the top ten largest global stocks would have generated an annualized return that was 3.4% lower than the overall global stock market. While the big tech companies are dominant players in their businesses, history suggests they may not be great investments at their current prices.
In the wake of the strong recent gains in tech stocks, a wave of successful technology companies that heretofore have chosen to remain private are considering going public this year via initial public offerings (IPOs). The ride-sharing company Lyft was first out of the gate in March and Uber, Lyft’s larger competitor, is slated to issue shares this month. Other tech companies in the IPO pipeline include Pinterest, Slack and Airbnb.
We often receive inquiries from clients wondering if they should purchase shares in these new issues. We generally advise against making significant investments in these stocks for a couple of reasons:
On average, the returns of newly issued shares have been disappointing. Per statistics compiled by Jay Ritter, a professor at the University of Florida, the average annualized return of all venture capital-backed IPOs during their first three years as a public company was just 7.2% over the period from 1980 through 2015. This compares with an annualized return of 11.5% for the S&P 500 over the same time period.
Second, we have no unique insights that allows us to confidently identify which IPOs will turn out to be great investments. Consider Lyft as an example. Lyft is an excellent company with promising prospects but everyone knows that. The question is whether Lyft is worth the $24 billion its IPO price of $72 per share implies and whether the investors buying the company at this price are wiser than those that are selling. Attempting to answer this question leads us into the realm of stock-picking – trying to outsmart thousands of other informed investors – and here we acknowledge our limitations.
We are firm believers that a successful long-term investment strategy should not be based on stock-picking but, instead, should emphasize broad exposure to asset classes at low cost.
1. Source: Morningstar
Written by Rich Golinski, CFA, Chief Investment Officer; [email protected]
|Index||Market||12/31/18 – 3/31/19|
|Standard & Poor’s 500||Large Co. U.S. Stocks||13.7%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||11.9%|
|Russell 2000||Small Co. U.S. Stocks||14.6%|
|MSCI All-Country World ex U.S.||Foreign Stocks||10.3%|
|Barclays 1-5 Year Gov’t/Credit||U.S. Shorter-Term Taxable Bonds||1.6%|
|Barclays Aggregate Bond||U.S. Taxable Bonds (Broad-based)||2.9%|
|Barclays 1-5 Year Muni Bond||U.S. Shorter-Term Tax Exempt Bonds||1.3%|
|JPMorgan Global Ex-U.S. Bonds||Hedged Foreign Bonds||3.1%|
Key economic indicators compiled by Jeffrey Blanchard, CFA, Director of Research; [email protected]
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