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The Cornerstone Investment Commentary: 3rd Quarter 2017

We experienced a solid quarter with strong investment gains across markets the world over and are also seeing evidence that markets are starting to give their greatest financial rewards to economies and companies with the most attractive valuations and profit growth – a sign that is always welcome when making portfolio decisions.

The stars continued to be international stocks with gains for the year running about 50% above the U.S. stock market due to both accelerating economic growth in many developed countries and more attractive stock market valuations.  Again this quarter, emerging markets stocks led the way with a gain exceeding 8%.  This environment, where economic recoveries internationally lag about 2-3 years behind the U.S. primarily due to unwise interest rate increases overseas in 2011, is now favorable for foreign growth stocks to outperform foreign value stocks.

In the U.S., small-cap stocks out-gained those of large companies for the first time since the fourth quarter of 2016.  This is likely due to prospect for tax cuts, the dollar’s sharp ~10% fall this year which hits large multinational firms hardest and because expectations of stronger, sustained economic growth are fading somewhat.  This has also kept commodities in-the-red for 2017 as inflation remains dormant.  One particular detail that bears watching is that in the U.S., value stocks fared notably better than growth stocks in September for the first time this year.

Finally, both real estate (REITs) and bonds gained less than 1%; each is susceptible to the Fed’s ongoing regimen of interest rate hikes.  Our moves a year ago to decrease real estate and shift your fixed income mix to be at least 80% invested in holdings with average maturities of less than two years continues working to your benefit.

Now that we are firmly in an environment of steadily (though slowly) rising interest rates, it’s a good time to recall the ways this impacts diversified portfolios like yours:  1) Higher-dividend paying stocks become less appealing as other interest-paying choices start to be more attractive; 2) In time, returns from stocks will fall since higher interest rates increase business expenses, which lowers profits and their growth; 3) Interest rates on existing bonds, which are fixed until maturity (hence their ‘fixed income’ descriptor), become less attractive and cause bond prices to decline  – the longer the term/time until they mature and can ‘reset’ at new and higher rates, the more they fall.

There is one portfolio change to make in light of this.  With foreign growth stocks holding an advantage over value stocks and to tilt foreign equities in this direction, we sell 1/3 of your Global Dividend holdings (Thornburg Investment Income Builder – TIBIX – with its 60/40 mix of Foreign/U.S. higher-dividend-paying stocks) to buy low-cost ‘institutional’ shares of Vanguard International Growth Fund (VWILX) in as tax-efficient a way as we can.

Beyond this, we believe your portfolio is well-positioned for the ongoing objectives you ask it to meet and today’s conditions.  As always, we invite your comments and questions.  Thank you for the continuing opportunity to work with you.  We send our very best wishes to you and your family for holidays that just were, or soon will be, upon us.