The current stock market environment is a difficult one for even the most experienced of investors. The Federal Reserve has begun to raise interest rates in a period of time when American companies are competing globally against a backdrop of significant trade unrest. These potential headwinds for stocks are mitigated in part by the large corporate tax cuts. Companies’ increased cash flows are being redeployed as wage hikes, dividend increases, stock buybacks and a nascent revitalization in large scale mergers and acquisitions.
In the midst and perhaps because of this uncertainty, investors have gravitated to fewer and fewer stocks. Investors have embraced the fastest growing and largest technology companies represented in the NASDAQ while avoiding more industrial companies represented in the Dow Jones Industrial Average (DJIA) and the S&P 500. Through 6/30/2018, the NASDAQ has returned +8.79% YTD compared to +2.65% for the S&P 500 and a -0.73% for the DJIA. Bonds as represented by the Barclays Aggregate Bond Index are also down -1.62% YTD at mid-year reflecting the impact of the Federal Reserve hikes.
Given the near 10% performance disparity at mid-year between the Dow and NASDAQ, it is difficult for investors to assess how one’s portfolio is doing in this environment. Comparing your portfolio to a particular stock index is known as benchmarking. Benchmarking can be a useful tool in assessing how your portfolio is doing in particular economic environment however benchmarking is not an effective tool in assessing whether your portfolio is successfully reflecting your risk appetite. For example, while most would enjoy the returns the NASDAQ has returned over the last couple of years, few of our clients would relish the volatility that is associated with those returns. Additionally, the fact that most of the NASDAQ performance can be traced to about six stocks means very few investors could expect to outperform in such an environment. The fact that most investors also value dividends means S&P 500 and DOW stocks should have a place in most portfolios.
Financial stocks and energy companies also represent much larger components in the S&P 500 and DJIA than the NASDAQ. They also represent larger industries that can add needed diversification in a portfolio even in periods of underperformance. The composition and nature of prominent indices are discussed in another article in this newsletter. Your investment advisor will be more than happy to further explain the benefits of a broadly diversified account.