A Sideways Summer That Tested Traditional Portfolios

After a strong start to the year, investors spent much of the summer learning an important lesson: markets don’t have to crash or even decline to become difficult.

Since the end of May, the S&P 500 has made surprisingly little progress. Small-cap stocks have fared worse, giving back some of their earlier gains, while many international markets have also struggled to maintain their previous momentum. At the same time, bonds — traditionally the portion of a portfolio investors expect to provide stability when stocks become uncertain — have faced significant pressure.

The culprit has largely been a familiar one: interest rates. At the end of May, the 10-year U.S. Treasury yield stood near 4.45%. By late September, it had climbed above 5%, reaching levels not seen since 2007. The pressure hasn’t been limited to the United States. Long-term government bond yields in the United Kingdom, Germany and Japan have also reached levels not seen in decades.

Remember that bond prices and bond yields move in opposite directions. When yields rise sharply, existing bond prices fall. That relationship has made the past several months particularly challenging for traditional portfolios.

Adding to the pressure has been another familiar inflationary force: energy. Oil prices moved sharply higher during the summer amid geopolitical tensions and concerns surrounding global supply. By mid-September, oil was up more than 70% for the year, creating renewed concerns that higher energy costs could keep inflation elevated and interest rates higher for longer.

For investors, the combination has created an unusual environment. Stocks haven’t collapsed, but they haven’t provided much reward either. Bonds have struggled at the same time. And many of the assets that performed well earlier in the year have lost momentum.

For a trend follower, however, periods like this reinforce why we believe the ability to adapt matters more than the ability to predict:

• At the end of May, we didn’t need to forecast where oil would trade in September, we already held long exposure.
• Similarly, we didn’t need to predict that the 10-year Treasury yield would eventually exceed 5%, we already had minimum exposure.
• And we certainly didn’t need to determine exactly when stocks might stop advancing.

Instead, our systematic investing process continually asks a simple question: Are the trends that justified owning an investment still intact? That distinction matters. Trend following will never perfectly identify the top of a market. By design, we need evidence that a trend has changed before responding. That means there will always be some amount of retracement as markets transition from one environment to another.

But that “cost of confirmation” serves an important purpose. It keeps us from reacting to every headline, every bad trading day, and every prediction about what markets might do next.

Despite a challenging summer across several major asset classes, our trend-following strategies have held up well. More importantly, they remain positioned to respond if the weakness we’ve seen since May develops into something more significant.

We don’t know whether stocks will resume their advance, interest rates will retreat, energy prices will cool, or recent weakness will accelerate into a more meaningful decline. Fortunately, we don’t believe we need to know. Our job isn’t to predict the next move. It is to participate when trends are favorable, manage risk when they deteriorate, and keep portfolios aligned with the long-term financial goals they were designed to achieve. Sometimes markets move higher. Sometimes they move lower. And sometimes, as we’ve experienced recently, they simply go nowhere. A disciplined process should be prepared for all three.