Stocks may have turned the corner following their summer swoon. The S&P 500 has rebounded 11% from its low on August 24, owing to soothing comments from the Federal Reserve, renewed expectations for economic stimulus overseas, and stronger than expected corporate earnings.
In retrospect, the market decline was unusual in nature.
First, richly priced stocks outperformed, led by aggressive growth stocks (top chart). This means that conservative stock mutual funds did not necessarily provide good protection during the sell-off. Dont count on expensive stocks to outperform during future downturns, however. High P/E stocks are usually hit hard during a recession.
Second, dividend paying stocks underperformed during the sell-off (bottom chart), principally among economically sensitive sectors like industrials. Again, this meant that conservative stock mutual funds did not provide their usual degree of protection. It was the first occasion in at least thirty years that dividend paying stocks underperformed in a downturn. We view this as an aberration, and believe dividend-paying strategies should remain foundational to portfolios.
A third unusual dynamic was that safe bonds like U.S. treasuries did not rally significantly, and therefore did not provide strong gains to offset the decline in the stock portion of portfolios. The following chart reveals that 1994 was the last time that treasuries did not gain during a stock market sell-off. Low interest rates mean that investors should have modest return expectations for bonds, including during market declines.