The value of staying invested: Insights from our Q1 Economic and Market Review

Executive summary:

Investors may be concerned that the surge in U.S. stocks in Q1 could spark a pullback, but history shows that strong performance to start the year can often lead to a positive return for the full year
While the Magnificent 7 has ruled supreme for the past few years, it may be time to look at the GRANOLAS, a group of stocks from Europe with some interesting characteristics
Investors may also be concerned about how stocks will react to the uncertainty surrounding the presidential election in November. We look at how stocks have behaved in past election years
And three years after the start of the COVID pandemic, we look at how investors who remained true to their plan fared compared to those who took a step back. Once again, we find that remaining invested through the market’s fluctuations pays off in the long run

We’ve just come through the first quarter of 2024 – and what a quarter it was! Hard on the heels of a robust end to 2023, the S&P 500 Index rose 11% in the first quarter of this year. This is the first time since 2012 that it’s had back-to-back double-digit quarterly returns. What does that mean for the rest of the year, and what else should we be thinking about as 2024 unfolds?

I think it’s going to be an interesting year with presidential elections in November, the imminent sunsetting of the Tax Cuts and Jobs Act on the horizon and the prospect of lower interest rates impacting the bond market. With so much uncertainty, you may have clients who want to step back from the markets. I’m going to show you why that’s not a great idea – and give you some background information to help you keep your clients invested.

Let’s take a look at some of my favorite slides from our Q1 2024 Economic and Market Review.

What's driving performance?

This chart from our latest Economic and Market Review shows U.S. stock returns surged by more than 10% in the first quarter.

Source: Morningstar. As of 3/31/2024. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

While this recent strength in the market may cause investors to be worried a pullback is imminent, large gains to start the year have not traditionally been followed by weakness through the rest of the year. Since 1970 the S&P 500 Index gained more than 10% during the first quarter in 10 different years. In all but one of those years, the market continued to move higher in the remaining three quarters to produce additional gains, with the one exception being 1987 after the historic “Black Monday” stock market crash in October of that year.

This emphasizes the importance of adhering to a long-term investment plan rather than reacting to short-term fluctuations. Of course, past performance is no indication of future performance, but the odds do appear to be in the favor of those who remain in the market.

What are the GRANOLAS?

Let’s talk about global diversification. It's essential to consider stocks beyond our domestic border. While the term "GRANOLA" may not ring a bell, these non-U.S. stocks, characterized by their diversified nature and strong performance, present compelling opportunities for inclusion in portfolios. How did the name GRANOLAS get chosen for this group of stocks? Take a look at the first letter of each of the company names – and you can see how it resembles the word.

If you are wondering more about the Magnificent 7: the market is starting to notice the ongoing changes of the Magnificent 7 over the past four months. We believe that the long-term performance of the Magnificent 7 stocks will be determined by the underlying performance of their individual operating models. Without making a specific prediction about the companies involved, we believe that active managers (like Russell Investments) will be able to detect the relative potential returns of each and adjust their portfolios accordingly.

It's commonly said that diversification is the only free lunch in markets. Investors would do well to keep this in mind, as in "The Magnificent Seven" movie from which this term is derived, only three of the seven may survive the final battle. My colleague, Chris Banse wrote a piece on market concentration and the Magnificent 7 in February – it’s a great read!

Source: Morningstar data as of March 31st, 2024. Growth of assets based on index data from S&P 500 Index TR and Euro Stoxx 600 NR Index USD. Alphabet represents combined A&C shares. “Magnificent 7” refers to Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla and Meta. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Fixed income

Shifting our focus to the fixed income landscape, the recent downturn in the bond market can be attributed to the upward movement of interest rates. With most observers expecting the U.S. Federal Reserve to cut rates a couple of times before the end of the year, there is likely to be some significant hiccups in the bond market going forward. Nevertheless, it's crucial to recognize that bonds continue to play an important role in diversified investment portfolios, particularly when evaluating the broader trends in long-term interest rates.

Source: U.S. Treasury and CME Group. Expected Fed Funds rate represents highest probability target range at each month end based on market pricing. Based on expectations for December 2024 Federal Reserve meeting. Forecasts are not guaranteed, and actual outcomes may differ.

Thumbs down

Turning to tax considerations, the impending sunset of the Tax Cuts and Jobs Act in 2025 prompts us to reassess our tax strategies. Here I am going to cite our director of tax-managed solutions, Rob Kuharic :

“…the outcome of the election will influence the different tax changes that are major parts of the Tax Cuts and Jobs Act of 2017 (TCJA). The three major items we are focused on are 1) a reduction in the standard deduction, 2) the estate tax exemption declining substantially, and 3) the income levels of the tax brackets being reduced as well as tax rates increasing.”

This year is a big year with elections and it's important to anticipate potential tax increases and plan accordingly. If you have not explored more about Tax Managed investing – take a moment and explore how compounding tax drag can continue to weigh down portfolios and reduce returns.

Source: Russell Investments

Election year

The buildup to this year’s election is starting to dominate the headlines. We are seeing trends in the market with investors increasing cash holdings due to election uncertainty. Remember this: historical data shows that neither party consistently wins elections, and markets tend to rise regardless of which party is in office. Take a look at the visual below. This shows that a 60/40 portfolio delivered positive returns in the last 20 out of 23 election years.

Here is my advice: financial advisors, encourage your clients to reflect on their investment journey and goals amidst different administrations; in your role as a behavior coach, help them resist the urge to adjust their portfolios based on political outcomes – like I say: “don’t mistake your planning with your politics.” Stay the course and recognize that markets typically trend upward irrespective of political shifts.

Source: The American Presidency Project & Morningstar Direct: 60/40 Portfolio: 60% U.S. Equity / 40% Bonds. U.S. Equity: Ibbotson U.S. Equity Index (1932 – 1969), S&P 500 Index (1970 – Present). Bonds: Ibbotson Intermediate Bond Index (1932 – 1975), Bloomberg U.S. Aggregate Bond Index (1976-Present). Cash: Citigroup 1-3 Month T-Bill Index. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Stick to your plan

Finally, a chart depicting the COVID-19 market downturn which highlights the importance of staying invested. The uncertainty which we felt at home and in our portfolios surrounding the pandemic was unprecedented. As this illustrates – if an investor moved to cash in March 2020 – and re-entered at various points, they would have had a difficult time catching up. If they went along for the bumpy ride, their portfolio should reflect that the pain was worth the hopeful gain. It’s important to remain steadfast and resist the emotional reaction to market fluctuations – trust me, I know it’s hard. But when you help your clients remain invested through thick and thin, you can provide a lot of value.

Source: Morningstar Direct. Balanced Portfolio: 60% S&P 500 Index & 40% Bloomberg Aggregate Bond Index. As of March 31, 2024.

Let's reflect on some key takeaways from our Q1 Economic and Market Review:

Remember, short-term performance spikes don't necessarily forecast long-term trends, so stick to your plan rather than succumbing to fleeting market noise.
"Granolas" – those often-overlooked non-U.S. stocks -- can offer compelling opportunities for diversification and growth. Speaking of overlooked, don't discount the importance of fixed income despite recent downturns; bonds still play a crucial role in diversified portfolios.
Thirdly, with elections looming and potential tax changes on the horizon, it's vital to anticipate and plan accordingly. Remember, historical data shows that regardless of who's in office, markets tend to rise over time. So, don't let politics sway your investment decisions; stay focused on your financial goals.
Finally, a poignant reminder from the COVID-19 market downturn: staying invested through uncertainty pays off in the long run. Your clients will tend to be better off if they don’t react emotionally to market fluctuations, and trust in their investment plan.