Client Letter – Q2 2018

During the past quarter, the best performing asset classes were U.S. small growth stocks, U.S. small value stocks, and real estate.  The following chart shows the 1-month, 1-year, and 5-year performance of many DFA funds (representing different asset classes) compared to the S&P 500 Index:

Market Returns for the period ending June 30, 2018

DFA Fund / Index1 Month Return1 Year Return5 Year Return*
S&P 500 Index3.4314.3713.42
DFA U.S. Large Value0.3710.1911.86
DFA U.S. Small7.0015.3112.22
DFA U.S. Small Value7.7615.0110.80
DFA Real Estate (REITs)8.684.258.45
DFA Int’l Large-1.377.416.47
DFA Int’l Large Value-3.308.956.58
DFA International Small-1.969.3010.39
DFA Int’l Small Value-3.475.4010.09
DFA Emerging Markets Core-9.875.175.00
DFA 5-Year Global Bonds0.550.591.82
DFA Inflation Protected Bonds0.761.731.67

*Note: Returns for periods greater than 1 year are annualized.  Top 3 returns are in bold.

An international trade dispute and rising interest rates weighed on investment markets in the second quarter. Small stocks and large technology stocks notched big gains, but other market sectors fell, some sharply.  We never know what the future will hold, but market trends like we’ve seen recently increase our conviction that investors should proactively assess the risks in their portfolios to make sure they are comfortable with them. The secret to successful investing is not trying to sell before market declines and buy before upturns, but being comfortable holding a portfolio through thick and thin. Market timing does not work; holding a well-diversified, risk-controlled portfolio over time does.

The tariff conflicts started by the United States have weighed on large industrial companies and others dependent on trade. The Standard & Poor’s 500 Index, which is dominated by such companies, eked out a gain of a little less than 3% during the quarter. Stocks of smaller companies, many of which do most of their business locally and are not affected by trade disputes, were up nearly 7.5%, as measured by the Russell 2000 Index. That’s a big difference, and such divergent performance is part of the reason we believe it is always wise to invest some money in small companies.

One of the most worrying trends was the continued rise in a few big tech stocks, such as Netflix, up 32.5% in the quarter; Facebook, up 21.6%; and Amazon, up 17.4%. Trees don’t grow to the sky, and years of fast growth in these stocks will come to an end someday, and that ending could get ugly. We are reminded of the year 2000, when the rest of the stock market peaked in January and began falling, while the technology-heavy NASDAQ index climbed to a record high in March 2000, only to fall sharply over the ensuing three-year bear market. The NASDAQ languished for 15 years before recovering to a new high; many years after the rest of the stock market had done so. In that bear market portfolios, holding international, small, and value stocks lost less than the NASDAQ and the S&P 500 stocks and recovered their losses sooner.

Among other asset classes we own, emerging markets stocks slumped nearly 10% this quarter, but it’s 1-year return is a respectable 5.17%. We maintain limited exposure to emerging markets because the swings on performance are often sharp and wide. Despite this quarter’s declines, we are mindful of other years, such as 2009, when DFA’s Emerging Markets Value Fund, for example, returned 92%! Yes, there is reward for taking risk.

Meanwhile, we are seeing an explosion of online fraud this year. We urge you to secure your online accounts and assets by using complex, randomized passwords; by keeping them in a secure password keeper application (such as LastPass); by turning on two-factor authentication for access to key online accounts; and by setting a password for your home Wi-Fi router. Ironically, you can’t escape online fraud by simply refusing to participate: If you don’t set passwords and secure your online access to Social Security, bank, investment, and credit accounts, you risk the chance that someone else will.

We hope you have a relaxing and enjoyable summer. Please don’t hesitate to call or email if you need anything.

Warm regards,

Chris signature

About Christopher Jones

Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.