Against the odds...
June 30, 2023
June 30, 2023
And out of nowhere—equities have entered a bull market, up 22% from the October 2022 lows through June 27, 2023!1
While this will be the common theme of the second quarter postmortem commentaries about to hit your inbox, like many new bull markets, this one came when least expected. If we go back only a few months, we remember just how bad things felt when, last year, the Standard & Poor's 500 Index lost over 18% and the Bloomberg U.S. Aggregate Bond Index lost 13%.
With interest rates at yields not seen in 15 years, many predicted that the TINA (there is no alternative to equities) trade was dead and forecasted much better risk-adjusted returns for bonds. Heading into 2023 the average forecast of the S&P 500 as reported by Bloomberg called for a negative return in 2023—the first time since at least 1999.2
Despite such doom-and-gloom expectations for equities and competitive starting yields on money markets and fixed income, equities have rallied significantly from their lows last year and investors who were able to “tune out the noise” were rewarded for staying the course. What is most often lost in the conversation is not the rally in the markets from such dire outlooks, but whether your clients fully participated in the rally and if their allocation match their investment policy coming out of the 2022 bear market.
The 2022 to 2023 reversal was swift, as shown in Figure 1, below, and came without an all-clear signal.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
It has been extremely difficult to time the markets where just missing a few days in the market can dramatically affect the investors’ long-term return. This impact from getting it wrong is shown here, where missing the 10 best days since 1988 would have led to annualized returns 2.5% lower than staying invested. And unfortunately, the best and worst days tend to occur near each other in clusters.
While most investors won’t try to time daily ins and outs of the market, the impact of a more likely scenario, where an investor is out of the market for quarters rather than days can be seen in Figure 3. As expected, given the wide dispersion of quarterly returns, missing only a few of the best quarters can lead to significant underperformance; but what is often overlooked is the resulting impact on your client’s ability to meet their goals. In short, bailing from the market and subsequently missing quarters with positive performance can undermine the entire process of retirement and goals-based planning.
The challenges of market timing have been well documented. Specifically, strategic asset allocation has delivered a tighter distribution of outcomes, which led to significantly better client outcomes, which is critical for advisory practices focused on goals-based financial planning. We found that strategic asset allocation strategies have significantly outperformed most tactical asset allocation strategies, averaging about 2.0-2.5% annually over the last 20 years. The significant underperformance of tactical strategies highlights the challenges these managers face in predicting the direction and magnitude of market shifts. In Vanguard’s Advisor’s Alpha®, we discuss a more prudent approach to improving your client outcomes.
So how did advisors and their clients do with staying the course with the whipsaw performances in 2022 and 2023 year to date?
Figure 4 shows that allocations to equities and bonds have held steady in the past few years and near their long-term medians despite many headwinds, including the poor performance in 2022, negative headlines, pessimistic outlooks, and money markets and bonds offering yields close to many equity forecasts. Advisors who remained steady benefited from equities rallying against predictions to the contrary. This is quite different from the dramatic reduction in equity allocations that we saw during the dot-com collapse, the global financial crisis, and even to a lesser extent, Covid-19.
Despite the performance whipsawing and the doom and gloom narrative, most advisors have successfully tuned out the noise and have paid close attention to the 3B mental model we shared last quarter. These three Bs – business model (incentives to grab your attention), biology (fear and stress shrinks time horizons) and behavior (reacting to the noise and shorted time horizons during periods of stress)—are critical to understand when helping coach clients through uncertainty. Given asset allocations stayed the course, undeterred by the volatility in performance and the dismal headlines, we congratulate advisors for coaching their clients through these challenging times and giving them the best chance for meeting their goals. We’d encourage you to use the opportunity to review these decisions with your clients and reinforce the value that was added from doing so while also reinforcing these positive outcomes when the need for coaching inevitably arises once again. Our market hindsight tool can help make this real for your particular client situations.
This is another positive trend in the advisory community, as more advisors are moving further into goals-based financial planning where they have a much higher probability of adding value for their clients as opposed to trying to predict the future of the financial markets. This allows advisors to focus on their clients’ real questions—such as how much do I need to retire, how long will my money last, and how will taxes impact my spending. The long-term financial projections advisors use to answer these questions for their clients assumes their clients are fully invested in their target asset allocation over the entire planning horizon.3 As a result, being out of the market—even if only for a quarter—undermines the entire financial planning exercise given returns aren’t average and can vary dramatically through time.
Helping your clients stick to their financial plan and stay invested, even when it is difficult, gives your clients and your practice the best chance for long-term success!
1 Source: Vanguard using S&P 500 Index data as of June 27, 2023.
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