Following a devastating decline of nearly 50% suffered during the aptly named “Great Recession” (December 2007 through June 2009) the stock market, as measured by the S&P 500, has reached new all-time highs. The advance has become even more pronounced since the 2016 presidential election.
Given this factor alone, you’d think the world’s economies and our investment portfolios would be booming in a way that would match those milestones. But you’d be wrong.
Actually, the economic recovery following the recession has been rather subdued. Not bad, but not great either. And, apart from a recovery in housing, returns on investment grade bonds and other traditional investments have been lackluster as well for most people, at least compared to historical norms.
Why? Here’s a simplified formula:
Fewer high paying jobs for millennials who are replacing higher salaried retirees in the workforce results in lower levels of income which the government taxes (Gross Domestic Product, GDP) and then uses to support/fuel the economy.
At the same time, both government and consumer debt has increased dramatically since 2007. Consequently, principal and interest payments now take a larger share of the government’s GDP, and consumers’ after-tax income, to service the debt.
Fortunately, in the short term, the U.S. Federal Reserve Bank (Fed) monetary policies over the past decade have significantly disrupted the customary economic cycles, and created an environment of historically low interest rates. That said, we are worried the party may be over and interest rates could rise to a level that could cause significant stress on the economy.
We are also concerned that slower growth in GDP may eventually translate to lower corporate earnings and, hence, lower stock values. Compounding the issue is the fact that equity market valuations are historically high. This could ultimately mean lower returns on the traditional investments that make up your 401k and other investment vehicles.
Unfortunately, we don’t see this trend improving much in the long term, but rather see a new normal settling in the markets. Going forward, we believe that long-term returns in the traditional U.S. equity markets could likely average between 3-5%, over market cycles, versus the historical average of 7-9% in previous years.
Who knows when interest rates will rise, but with the interest rate on the benchmark 10-Year U.S. Treasury Bond at 2.37% compared against the long-term average of 6.25%, it would seem highly likely that rates will inevitably rise. Because bond prices fall as interest rate rise, this would suggest that risk in the U.S. government securities and investment grade bond markets is high.
The Goldilocks Zone
This isn’t to discourage you from investing, but rather to make you aware of the long-term scenario. And it doesn’t mean you can’t reap good returns from your portfolio today or in the future. It simply means you have to invest smarter. You can’t just sit on autopilot anymore.
There are several positives at the moment, therefore things don’t look bleak in the short term. Importantly, there are few traditional warning signs pointing to an immediate recession.
And that makes it the perfect time to review your portfolio and make sure it’s in the “Goldilocks Zone” before the bears return.
What does this mean exactly? You need to work with your wealth management advisor to make sure your investments strike the right balance between high-return opportunities and your personal tolerance for risk. This may include looking at less-traditional alternative asset classes such as real estate, hedge funds and natural resources.
These alternative investments can help you protect your portfolio by mixing in opportunities that have lower correlations with the stock and bond markets (i.e., if traditional markets tank, your portfolio is far less likely to.)
Strategic alternative investments have also become more accessible and less risky for investors today, by finding the right opportunities that fit your needs.
That’s where we come in, and we’re happy to help answer any questions you may have. Click here to reach out to us today.