Put markets in perspective

Opening

This is Mark Peterson with the June 2024 Student of the Market update.

Slide 2, 00:07

Let's begin this month. We'll touch on a handful of things. We'll talk about US stocks in an election year. That seems to be a very hot topic. Folks can't seem to get enough on the election and the impact of the market. Then, we'll talk about the slow start for bonds, how active and some flexible fixed income funds have led the way. Then finish up with alternatives, a story I've wanted to touch on for a while, looking at how alternative mutual funds are much, much improved over the years in a much better place today than they've been in the past. Better variety, better quality, better providers and managers than we had 10-20 years ago when they first came to market.

Slide 3, 00:50

So, let's jump into the stock story, talk about election years. Fourth best start through the end of May. In 2024, up 11.3%. Only 1928, 1976, 1948 were better. And most importantly, the right side of the slide, you can see any positive start to an election year since 1928. On average, the next seven months after that positive start were up 11%. You can see that in the bottom right-hand corner of the table. And only one of those calendar years was negative. Only 1948 was negative over the next seven months, but the year still finished positive in 1948. So, just a good sign historically when you get off to a good start in an election year, generally that momentum carries through. If you recall last month, we touched on there's only been four negative calendar years out of 24 election year since 1928. If you start off to a good start, your odds even improve from there to have an overall positive year, at least historically. So, hopefully, that momentum carries through.

Slide 4, 02:03

Switching to tech stocks, certainly been driving the market. The MAG7 last year was certainly a big story. Those very largest names, a lot of those technology names at the top of the index last year, driving all the performance. Certainly not as bad this year, but still elements of that. You have some stocks like NVIDIA making investing look very easy. Just invest in some of the biggest, brightest technology names and call it a day. But I think it's good to zoom out and remind ourselves, remind investors, that it's not always that easy. And you can see over the last five years, there's about 482 individual tech stocks on the New York and NASDAQ stock exchange. Almost half, 43%, have actually lost money over the last five years, which is crazy to think about given the run they've had over the last 18 months or so. And you compare that, of course, to a mutual fund that's invested in technology or an ETF that focuses in on technology, only three out of 98 have lost money. So about 4% of those diversified mutual funds, diversified exchange-traded funds focusing in on technology have lost money over that stretch. So, just a good reminder that additional level of diversification certainly can bring some downside protection to the table. I think sometimes in this type of market, it's easy to forget sometimes how tough investing in some of these sectors can be. And on the right side, you can just see the amount of loss. So, it's not just that they're down. Some of these are down. Over a third of these are down more than 25% over the last five years.

Slide 5, 03:52

Switching gears on the bond and stock correlation side, we highlighted this a couple months ago but it's actually continued to head higher and break records. You can see that May of 2024, highest correlation that we've ever seen between stocks and bonds. So, just measuring how much stocks and bonds move in tandem. They've never moved more in tandem than they have over the last three years. On the right side, we just highlight the fact that when correlation matters most. And that's usually when stocks are negative. Look at the last three years. Whenever stocks have been negative, and there's been 14 of these months in which we've had stocks lose money, starting with September of 2022, down 9.2%. But 13 of these 14 periods where stocks lost money over the last three years, bonds also lost money in those same months. So, that correlation has been the highest when you needed it the most. And that's a contrast from history. You can see the last seven months, one positive out of 14 months is about 7%. Historically, it's closer to 40% of the time. Whenever stocks are negative, bonds are positive, about 38% to be exact. So, you can see what a disconnect that is. Where bonds just haven't delivered like they have in the past and had positive returns when stocks were negative. It's only happened 7% of the time over the last three years where historically longer term it's closer to 40.

Slide 6, 05:33

Moving ahead, certainly taxes have been a big topic of conversation for a lot of folks, a lot of gains in some of those top names in the index, or maybe you have a fund or an ETF with a lot of gains in it. Just wanted to run the contrast here between mutual funds and the stock and the bond side and what they have from an embedded gain and loss standpoint. So, these are potential cap gains that could be paid out in the future. On the stock side, it's always an issue. I think we all know that. Over 80% of stock mutual funds have embedded gains, meaning they have gains that have not been paid out yet. And on the right side, you can see that average per stock fund is around 17%. So, 17% of the fund is actually embedded gains. And contrast that on the bond side, I know certainly bond mutual funds are gaining a lot of attention, but the reality is, bond mutual funds just don't have the same type of tax challenge that stock mutual funds have. You can see 96% of bond mutual funds actually have embedded losses on the bottom right-hand side, or excuse me, on the bottom left-hand side. And then, on the far-right hand side, you can see the average loss carry forward. On the bond mutual fund side is 20%. So, even greater than the cap gain exposure is the loss embedded in bond mutual funds because of the last couple of years and just the true nature of bond funds. They generally have less tax exposure. They'll occasionally have a higher yielding bond or bond that will have some losses to them. So, it tends not to be as big of an issue. So, I just wanted to draw that contrast. I know certainly folks understand the issues on the stock mutual fund side are a much bigger deal than on the bond mutual fund side, but just wanted to draw that contrast.

Slide 7, 07:25

We mentioned a slow start for bonds in the next slide. You can see actually it's the eighth worst start in history, only down 1.6%. It might not seem that dramatic, but again, in the bond world, that's actually the eighth worst start historically. The next seven months tends to be generally pretty good when you look at some of these worst starts historically. Of course, more recently, 2022 was the worst year in bond history, down another 4.5%. And then, you can see some others, a handful of other years where you lost money, but generally a positive picture, you think 3.5% over a seven-month window is actually not too shabby over that window of time. But I thought it was good to update the fact that we are off to a slow start for bonds. We've reset interest rates to a higher level. Maybe not a bad time to put money to work there,

Slide 8, 08:15

especially on the next slide in active and fixed income funds. If you look since the low in interest rates back in August of 2020, so going back to August of 2020, you can see what some of these categories have done. And the ones that tend to be very active, very flexible, that's non-traditional bond, multi-sector bonds, even that short-term bond space tends to be, has a very active and flexible feel to it. They're all positive since the low in interest rates back at the height of the pandemic versus some of the more core bond categories are negative. So, I think that flexibility has really paid off. And you see it in a more detailed way, just active versus index. I know you'll always get some folks who say, well, the index always wins, active never outperforms. Not the case on the fixed income side. You can see in the core bond and core bond plus categories on Morningstar, if we go back to 2020, that low in interest rates, you can see active has outperformed in a pretty big way. 80% of active has outperformed if we look at the oldest share class, strip out some of the others, strip out some of the index funds, as well. And then you can see on the bottom, more than 50% over every 1, 3, 5, and 10-year period. So, active flexible fixed income has really held in their well-added value above the core bond benchmark in this volatile interest rate environment that we've lived in.

Slide 9, 09:45

I mentioned the alternative story in the beginning. Something I've just experienced in my 30 years in the industry is, we brought alternative mutual funds maybe 10, 20, 25 years ago in a big way across the industry. And I think the story was good. I think there were a lot of good marketers of those alternative funds. The reality is they weren't good managers. So, the original versions of some of these alternative mutual funds aren't as good as they are today, and you can see that on the left and the right side of the slide. The right side, excuse me, the left side is just the returns by decade. Look at how much better returns are in the 2020s than even the 2010s or the 2000s and look at how the diversification. So, just the lower correlation to stocks, is what you're always looking for, looking to build in that diversification. Actually, that correlation's gone down, meaning there's better diversification. So, more return, better diversification. This is what I see across the board in this alternative mutual funds space, not just at BlackRock, but across the industry. There's just so much better strategies, and maybe it took some evolution, a little better environment where cash rates are paying more, so you're getting cash plus on a lot of these alternative strategies. We've touched on that, certainly, in Student of The Market, but I really think this is a big thing we need to acknowledge. I know a lot of folks out there haven't had a great experience with alternatives, but I can tell you, you look across the universe, what's available today, the managers are better, performance is better, diversification is better. I think it's good to acknowledge that and really get folks back on board here because this is another way to diversify, improve returns, to increase diversification. I think it's going to be critical to success. We've seen in the new bond era, even with interest rates higher, you're still going to have a ton of volatility. We need the diversification that alternatives can provide.

Slide 10, 11:45

And the last slide, as always, always try to mix in something on inflation. This is a correlation with inflation by asset class, which I think is always interesting. Just looking at what asset classes correlate the most... You know, a lot of people think tips should be at the top. They're not at the top. They're actually somewhere in the middle here. We'll put them back in there. But you can see commodities, no surprise, at the very top. But look at private credit. And some of these alternative strategies, multi-strategy, head funds as well, global macro, are some of the best asset classes from a correlation to inflation. None of them have a huge correlation to inflation, but they all have some tendencies where they'll react more positively to inflation. Certainly, private credit and bank loan have that floating rate nature to them. Certainly, alternatives can do better when inflation is higher because cash is paying more like we touched on.

Slide 11, 12:41

So, that does it for our June 2024 Student of the Market update. As always, if you Google BlackRock Student of the Market, you can find us out there. It is all investor-approved material. If you have comments or suggestions for content, please utilize our website there. Some of the best ideas come from investors across the country. Some of the questions and ideas for content, we certainly try to get in there as much as we can. But thanks again for listening. We'll see you next month on BlackRock's Student of the Market update.