Be Wary of Increased Concentrations in Stocks
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 03/15/19. Rates and Economic Calendar Data from Bloomberg as of 03/19/19. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global equity markets had one of the strongest weeks in the past 12 months as investors celebrated strong earnings, progress in U.S/China trade negotiations, and a delayed Brexit. In the U.S., the S&P 500 Index propelled substantially higher finishing the week at a level of 2,822, representing a gain of 2.95%, while the Russell Midcap Index followed suit gaining 2.40% for the week. On the international equities front, developed markets returned 2.81%, while emerging markets advanced 2.67%. Finally, the 10-year U.S. Treasury yield continued its gradual descent lower and finished the week at 2.59%.
In past issues we’ve discussed the likely re-emergence of volatility throughout 2019 at length. Increased periods of short term volatility is seemingly back and is here to stay for the foreseeable future. Naturally, as stock investors, we’re pleased to experience weeks like the last. However, we also recognize that the S&P 500 Index lifting 2.95% higher on the week is, in part, a byproduct of volatility. In other words, an investment that moves 2.95% higher in a week can just as easily depreciate 2.95% over the course of a week. In our opinion, strategies that pursue a broad-based, diversified approach designed to mitigate concentrated exposure to any single company are more likely to weather the volatility storm.
Take for instance, the historical volatility of the individual stocks that have comprised the S&P 500 Index since 1990, compared to the volatility of the S&P 500 Index over the same time period. The average total return of the individual stocks over the time period reviewed was 9% per year with a standard deviation of 45%. Statistically, this means that any of the individual stocks analyzed could have gained 55% or lost 36% in a given year, but ultimately averaged 9% a year. In contrast, the S&P 500 Index averaged an 11% return per year, along with a standard deviation of 28%. The main take-away being that the lower risk, lower volatility, strategy ultimately produced better results. Less variability, led to more consistent returns, which lead to better long-term performance.
Following nearly a decade of impressive U.S. stock market growth, many investors have developed heavy concentrations in individual companies, possibly without even realizing it. This imbalance, if left unchecked, could lead to elevated volatility and lackluster returns, which is why we encourage investors to revisit the diversification that may, or may not, be in place within their existing portfolios. If you would like to learn more about how we are helping clients invest dynamically and consistently with their own goals, time-frame and tolerance for risk, please do not hesitate to speak with your Hennion & Walsh Financial Adviser.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.