3 Key Themes for Your Mid-Year Investment Review

This article was originally published in full on Tacoma’s The News Tribune on July 1, 2024. Gary Brooks has been a contributing author for the paper since 2008 and is also a Partner and Senior Wealth Advisor at Mission Wealth in Gig Harbor, WA.

The Importance of a Mid-Year Review

Mid-year is a crucial juncture for you to take control of your investments and ensure they are in line with your long-term financial plan and any short-term financial needs. Conducting this review every six months is a wise practice. Doing it more frequently might lead to unnecessary changes due to market noise, economic fluctuations, and news distractions. On the other hand, delaying it could result in a significant deviation from your target balance of stocks and bonds.

3 Key Themes for Your Investment Review

As you review your investments, keep in mind three topics that have been prominent lately and may be due for change: the dominance of large U.S. growth stocks, subdued stock market volatility, and the role of cash compared to bonds. These themes will likely be relevant to your portfolio in the second half of the year.

U.S. Growth Stocks: A Cautious Approach

U.S. growth stocks have been the frontrunners in terms of returns for the past 18 months. They had to regain their market leadership just to catch up with value stocks, which fared better during the challenging conditions of 2022. The impressive gains of growth stocks might be a pleasant sight in your account balance, but they should be approached with caution.

In the broad U.S. stock market, large company growth stocks account for about a third of the total market value. This segment of the market started in July with a high price tag, trading at a 50 percent premium compared to their 20-year average price/earnings ratio. Unless company earnings exceed expectations, future returns from growth stocks are projected to be relatively low due to their high prices.

Value Stocks: A More Attractive Alternative

Value stocks, the counterpart of growth, feature companies that might not have the same ability to grow their profits but that more substantially pay back shareholders with dividends. They are relatively more attractive. While not trading at screaming-buy prices, they are less overvalued than their own history and much cheaper than growth stocks, meaning their future returns are projected to be higher than growth stocks.

Vanguard is one of many investment managers that endeavors to forecast future return cycles. The Vanguard Capital Markets Model has a 10-year projected return (50^th percentile of all modeled outcomes) of 1.4 percent for U.S. growth stocks and 5.1 percent for U.S. value stocks. The models and market history suggest this would be a poor time to trade out of value stocks to chase the performance of tech, artificial intelligence, or other recently high-flying themes.

Stock Market Volatility: Prepare for the Second Half

Instead of succumbing to the YOLO (you only live once) investing philosophy and investing heavily in trending stocks or sectors, it might be more beneficial to exercise some caution. This could involve adopting a defensive stance in stocks or even rebalancing your portfolio by reducing your stock holdings.

If history is any indication, we can expect more volatility in the stock market in the second half of the year. Since 1980, the average intra-year downturn for the S&P 500 Index has been 14.2 percent, even in strongly positive years. Only seven of the past 44 years have had an intra-year maximum drawdown of 5 percent or less.

The Role of Cash vs. Bonds

Outside of stocks, investors hold an all-time high of $6.45 trillion in money market funds, which currently present a nice parking place for savings with generally risk-free annualized interest of around 5 percent. This is adequate if you anticipate withdrawal needs in the next year.

However, if you are strategically holding money market funds, CDs, or short-term U.S. Treasury bills as an alternative to bonds in a long-term portfolio, market conditions and expectations of future interest rate direction suggest it may be worthwhile to begin shifting back to bonds.

Inflation has eased, economic growth appears to be slowing, and labor markets have softened a bit. This has led central banks abroad to begin reducing interest rates, with the U.S. potentially following suit later this year. Lower interest rates will immediately impact cash equivalent savings. Bonds, however, could receive a boost in returns by adding some capital appreciation to their existing income payments.

A gradual shift to intermediate-term bonds, particularly investment-grade corporate bonds, could offer enough extra compensation to make the small shift worthwhile.

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