FREE NEWSLETTER

Toil and Trouble

Jonathan Clements  |  September 11, 2015

AS I WATCH the recent market turmoil, three thoughts come to mind—and one great hope. First, I feel like a shopper waiting for the next sale. As of yesterday’s market close, the S&P 500 was down a relatively modest 8% from its May high. If this drags on, without any further decline, I’ll eventually do a little buying and selling, to bring my holdings back into line with my target portfolio percentages. But to get enthusiastic about stocks, I’d like to see the S&P 500 off 25% from its high—and, at that juncture, I would probably overweight stocks, with a special focus on emerging markets.

Second, what matters going forward is the real economy. So far, there’s been a lot of twitchy buying and selling, as investors anxiously peer into cloudy crystal balls. But whether we get that 25% decline, or we bounce back from here, hinges on whether global economic growth slows or continues to chug along. It’s going to take many months to get a good sense for what’s happening, which means investors need to be mentally prepared for some wild market swings.

Third, my time horizon is different from that of the typical Wall Street money manager, market strategist and securities analyst. They’re judged on their performance over the next 12 months, so that’s driving their trades and recommendations. My financial success depends on what happens over the next three or four decades.

My unpatriotic hope: We get lousy economic numbers and a sharp drop in share prices. I have full confidence that the global economy will recover before I need to sell any stocks and, in the meantime, I might get the chance to buy shares at bargain prices. What if we don’t get a big decline and I never get to overweight stocks? I won’t feel like I missed out: Long-run returns—at least in the U.S.—are unlikely to be impressive for today’s buyers, because we are starting from such rich valuations.

The Story So Far

My approach to keeping tabs on the global financial markets is super-simple: I just check the performance of various Vanguard Group index funds. What are the numbers telling us? Growth-stock funds are ahead of value funds not only in 2015, but also over the past five and 10 years. The performance gap isn’t enormous. Still, it’s a reminder that the academic research, which shows that bargain-priced value stocks have outperformed historically, doesn’t guarantee anything.

If value funds have been slight laggards, international markets have been a huge disappointment. Vanguard’s total international stock index fund clocked 3.9% a year over the 10 years through Aug. 31, versus 7.4% for its total U.S. stock market index fund. That translates into a hefty cumulative difference—a 46% total gain for international, compared with 104% for the U.S. These figures are for the “investor” share class.

In 2015, foreign markets are down less than the U.S. But that’s true only if you ignore the performance of emerging markets, which have plunged 14.2% for the year-to-date and have lost 0.8% a year over the past five years. Thanks to that rotten performance, emerging markets are arguably the cheapest sector of the global financial markets.

I also occasionally check the performance for Vanguard’s precious metals and mining fund, which isn’t an index fund and isn’t invested solely in gold stocks. It’s been a total dog. Over the past five years, the fund has lost a cumulative 57.4%. As a diversifier, gold has also been a disappointment this year: It has often notched gains on days when global stock markets are tumbling, but it’s still down 23.9% for the year-to-date. Nonetheless, for those who don’t mind the volatility, I think gold stocks are an intriguing addition to a portfolio, though I would cap exposure at 2% of a portfolio’s total value.

Demographics Is Destiny

Over the 50 years through year-end 2014, U.S. real economic growth clocked in at an average 3% a year. Half of that came from growth in the civilian labor force, which expanded at 1.5% a year. The other half came from the rising productivity of those workers.

We don’t know what will happen to productivity in the years ahead. But with aging baby boomers retiring, the labor force has been growing slowly—and we know it will continue to grow slowly. In the 14 full calendar years since year-end 2000, real GDP climbed at just 1.8% a year. Over that stretch, the labor force grew 0.6% a year, well below the 50-year average of 1.5%. Based on projections from the Bureau of Labor Statistics, the workforce will continue to grow at 0.6% a year between now and 2022. The implication: Unless we get a surge in productivity, which seems unlikely given recent modest levels of capital spending, U.S. economic growth will almost certainly continue to be sluggish.

Why does this matter? If the U.S. economy struggles, U.S. corporate earnings will probably also grow at a modest rate, unless companies can compensate through rapid overseas expansion. That means we’re likely to see muted stock returns over the next decade, though I suspect stocks will still handily outpace bonds.

Three Links

  • If you want to double check whether you have the right mix of stocks, bonds and cash investments, try the Investor Questionnaire at Vanguard.com.
  • Struggling to figure out the best strategy for claiming Social Security retirement benefits? Check out AARP’s calculator.
  • Every year, you should review your credit reports for errors. You can get free copies of your reports from the three major credit bureaus by heading to AnnualCreditReport.com.

First Steps

Want to get your children or grandchildren started as investors? If they had summer jobs, or they’ve already graduated college and are in the workforce, you might open an IRA for them. If they’re younger, you might fund a regular taxable account. Keep in mind that these accounts will count heavily against your family’s chances of college financial aid.

Assuming financial aid isn’t a concern, what should you buy? I would favor one of Vanguard Group’s target-date retirement funds. Not only will these funds give your children a broadly diversified portfolio in a single mutual fund, but also the investment minimum is just $1,000.

If you’re looking for something with an even lower minimum, consider Charles Schwab’s index funds, which have $100 minimums. You might start with Schwab’s total stock market index fund, and then later add its international index fund. Keep in mind that $100 sitting in a mutual fund won’t do anybody any good, so plan on adding regularly to the account over time. You can discover other low-minimum ways to get started as an investor in HumbleDollar’s money guide.

Hunting for Yield

The threat of rising interest rates continues to loom over the bond market. That makes it tricky for investors, who fear reaching for extra yield could come back to haunt them, because they might get hit with tumbling bond prices. To sidestep that threat, consider three strategies.

First, if you have a 401(k) plan at work, see if it includes a stable value fund, which should give you a moderate yield without any share price fluctuations. Second, you might buy five-year certificates of deposit. If interest rates climb and other investments become more attractive, you can always cash in your CDs, pay the early withdrawal penalty and invest your money elsewhere. Start your search for higher-yielding CDs at Bankrate.com. Third, you might head to TreasuryDirect.gov and buy EE savings bonds. True, today’s buyers receive a tiny 0.3% annual yield. But if you hold your EE bonds for 20 years, you are guaranteed to double your money—which means the return would jump to 3.5% a year.

Have a question or comment? Add it here:

Free Newsletter

SHARE