Midyear is a good time to assess investing strategy, looking back at where the markets have been and ahead at prospects for the second half.
Looking back at returns over the last six to 12 months will be enjoyable for many people because the stock market, the main engine for most investment portfolios, has performed splendidly.
Looking ahead, on the other hand, requires even more squinting than usual.
Market and economic forecasts are exercises in informed speculation. But with American politics in a muddle, any market outlook for the second half of the year is a leap into the unknown.
Fortunately, when I put on my investing hat, I try to ignore market forecasts and politics. Academic research suggests that sticking to a long-term plan using broad, low-cost index funds that track the world’s stock and bond markets makes sense for most people, most of the time.
Tuning out politics entirely isn’t realistic now. Course corrections are sometimes needed when the world changes in big ways. This could turn out to be one of those times.
Giants Rule
The S&P 500, the leading stock market index, returned nearly 25 percent including dividends in the 12 months through June — a glittering gain you may have approximated for yourself with a low-cost S&P 500 index fund.
But this windfall rested on a slender base. More than 70 percent of the S&P 500’s return through June this year came from just 10 stocks. And almost 30 percent of the overall return derived from just one company: Nvidia. It designs the chips that make artificial intelligence work. If you held Nvidia shares and nothing else, your investment would have gained 192 percent.
Say you did own a broad-based stock mutual fund or exchange-traded fund based on an index like the S&P 500. Diversifying your investments cut both ways. Yes, you were much worse off than pure Nvidia shareholders, because you held pieces of hundreds of stocks that basically went nowhere. Yet you benefited by owning large chunks of Nvidia — and of other giant stocks, like Microsoft, Apple and Meta, which accounted for much of the S&P 500’s rise.
I faced that quandary myself, because I favor a thoroughly diversified approach. For U.S. stocks, I hold a fund (Vanguard Total Stock Market Index) that mirrors an index much broader than the S&P 500: the CRSP US Total Market Index. It contains more than 3,500 stocks. The S&P 500 companies are included within the CRSP index and account for most of its gains now.
In the 12 months through June, it returned 23.2 percent, slightly less than the S&P 500. Over three months, it returned 3.3 percent versus 4.3 percent for the S&P 500. The smaller stocks in the broader index pulled down its returns.
But I’ll live with that happily. It’s a hefty return, and one day, perhaps, if market conditions shift, the smaller stocks will propel the index even higher.
How Funds Fared
Morningstar, the financial services company, has supplied The New York Times with information for decades on how mutual funds and exchange-traded funds actually perform. In the midyear data report, on average, these funds lagged the stock indexes. That bears out a long-term trend: Actively managed stock funds tend to underperform the market.
Over the three months through June, domestic stock funds, on average, returned 0.3 percent. Over the 12 months through June, they returned 17.4 percent.
For international stock funds, the pattern was similar. The average international stock fund returned 0.9 percent in the three months through June, and 10.2 percent over 12 months — underperforming broad indexes like the FTSE Global All Cap ex US Index and the MSCI ACWI ex US index.
I wrote last week about the dispiriting performance of bond funds. But because interest rates are already fairly high, the funds seem poised to do better.
Morningstar found that the average taxable bond fund returned 0.6 percent over the three months through June, and almost 6 percent over 12 months. Unlike the case for stock funds, these bond funds compared favorably with the main core investment-grade fixed-income index, the Bloomberg US Aggregate Bond Index, which returned 0.1 percent over three months and just 2.6 percent over 12 months.
It’s Complicated
Where the markets have been is the simple part. Where they are heading, no one knows. But that hasn’t stopped dozens of analysts from making predictions in reports that arrived in my inbox over the last few weeks.
Momentum — fueled, at the moment, by A.I. frenzy — is the main argument for the stock rally to continue. People are excited, and corporate profits for the overall market are growing. Barring an unforeseen disaster (and such things have been known to happen), it’s reasonable to believe stock prices will go higher.
But that very momentum is also a reason for stocks to begin a sustained fall, at some point in the not-too-distant future, if the economy falters or the mood in the markets sours. Rapid price increases can’t be sustained forever, after all. That’s basic economics.
Doug Ramsey, chief investment officer of the Leuthold Group, an independent financial research firm in Minneapolis, combined the two market themes nicely in a note to clients.
He compared this year’s U.S. stock market to the one in 1999, the dot.com boom. The stock market seemed frothy, driven by a handful of tech stocks — with the average share price too high for corporate earnings to justify. But the 1999 rally kept going for months. That tech bubble didn’t burst until March 2000.
“Only rarely does the stock market fall apart when it looks the most vulnerable,” Mr. Ramsey said. “Quite often, there’s another thrust higher that assuages the skeptical economists, strategists and chart watchers. It’s been the bear’s way of maximizing the number of occupants before the elevator goes down.”
At some date this year or next, a long-awaited Federal Reserve interest rate cut could well start a broader rally, he said. But history suggests that it would be unwise to get too excited if that happens.
In some previous cycles when the Fed began lowering rates — in 2002 and 2007 — it was smart to have shifted some of your money from stocks to bonds. The “initial Fed cuts provided last-chance exit opportunities,” he said, and that could well be the case in 2024, or whenever the Fed decides to cut rates.
It’s all a matter of timing — and no one really knows how to time the market accurately and reliably.
Just as the stock market has tended to rise over the long haul, it has endured declines of at least 10 percent quite regularly, too. The last such “correction,” as these market drops are known in investing jargon, was from July to late October 2023. Corrections of at least that size occurred every other year, on average, from 2002 through 2021, a study by the Schwab Center for Financial Research found.
Whether a big market decline comes this year, or next, or later — and whether it will be a run-of-the mill correction or something much worse — can’t be known in advance. But I’m absolutely certain about one thing: Sooner or later, a decline will come.
That’s why I always try to position myself for the long run, the next 20 years or more.
Hold enough high-quality bonds and cash to withstand a downturn. If you’ve enjoyed big stock market gains lately, it may be time to rebalance your holdings — shifting some money from stock funds to individual bonds, bond funds or cash, so you can draw on these funds when a downturn eventually comes.
The Problem of Politics
Then there’s the election. It complicates the outlook considerably.
Former President Donald J. Trump, the front-runner in most polls, is a felon and faces other criminal charges. Mr. Trump denies that he lost the last election. If he wins the next one, he is committed to disrupting the status quo on immigration, tariffs, taxes, regulation and countless other important matters, without spelling out exactly how.
President Biden, 81, says he is in the race until the last vote is cast. But because of continuing concerns about his capabilities as a candidate and as a leader, another Democrat — perhaps Vice President Kamala Harris — might replace him as the head of the ticket.
Assessing the possible financial impact of a Trump or Biden win — or an other-Democrat victory — is essential. Yet the situation is remarkably fluid. The possible outcomes are endlessly varied and radically different. It’s hard to know where to start.
As I’ve pointed out, long-term investors are generally better off ignoring elections anyway, because the connection between overall market performance and politics is fuzzy, at best.
What is clear is that significant turmoil can’t be ruled out. Making sure you’ve got enough cash to ride out trouble, and enough bonds for stability, is essential.
Once you’ve taken care of those critical needs, maintaining enough exposure to the stock market to give you a shot at exceptional long-term returns still strikes me as the best course for most people. But don’t be surprised if the second half of the year isn’t as calm as the first.