2017 has been a great year through the 3rd quarter in the market. Domestic markets have been positive all year with gains of 5%, 2% and almost 4% each quarter for the S&P 500. The performance has been very good so far for the stock market benchmarks but not all stocks are experiencing such positive gains. Below half of stocks were trading above their 50-day moving averages at the end of August. Generally in healthy markets more than half the stocks and usually more than 75% of stocks will be above those averages when the market is advancing.
The domestic market has been doing well over the past few years and while I do not expect a reason to reduce equity exposure, I do think it makes sense to rebalance and include an allocation toward international markets. It still appears that international markets are best positioned for above-average returns over the next five-to-seven years, with emerging markets in an even better position than developed international markets. However emerging markets in particular are not predictable.
Bonds still do not have many of the characteristics one looks for in a good investment. Interest rates remain low so the expected yield on corporate bonds remains low as well. The possibility that rates will rise only makes corporate and treasury bonds less attractive. At least with corporate bonds there may be some opportunity to find a suitable interest payment, treasuries pay much less and a rising-interest rate environment increases the risk the bond prices will decline. The benefit to treasury bonds, however, is if we have a shock to the market, they generally are among the best performers as investors seek a safe haven. Finally, high yield bonds, which offer better interest rates than higher-quality corporate bonds, are still expensive by historical standards and would likely drop in price with either higher interest rates or a slowdown in the economy. High yield bonds are more economically sensitive than investment grade corporate bonds, mortgage bonds, or treasury bonds.
It seems that the positive trend in the market may continue because inflationary pressures and tightening monetary policy may be deferred longer than historical comparisons. Global interest rates are near record lows and several developed international market central banks are committed to quantitative easing until inflation rises to their targets. The money printed by the Bank of Japan and the European Central Bank will likely dwarf any reduction in our own Federal Reserve balance sheet.
This may be a good time to rebalance your portfolio since we’ve seen many years of positive performance in the domestic market and consider increasing exposure to the international markets where future returns will likely be above average.