Investing Through Adversity Investing Through Adversity

The Long View2018 Edition, Issue 1

Investing through adversity Investing through adversity

“I think the most important After a long, calm period of relatively strong returns, global equity markets gave way to a jarring thing is to keep a long-term bout of volatility earlier this year. The turmoil served as a reminder that markets can and will change, orientation. Trying to fgure and that a measured, long-term approach to investing is paramount in today’s environment. out what the market’s going

to do today or even next week Overdue and not entirely unwelcome: economy is in its best shape in years, means reallocating to bond funds that is an impossible task and one That’s one way to look at the correction and Europe is on the rebound. Overall, offer the potential for both solid income that I don’t think is helpful to in the S&P 500 earlier this year. Although the International Monetary Fund expects and diversifcation from equities,” Mike says. creating long-term wealth.” swift declines can be unsettling, they global GDP to hit 3.9% in 2018. have long been part of the investment “We still feel good about the economic Tim says the most important thing to environment. tim armour backdrop for corporate earnings, and we do during periods of volatility may be portfolio manager “We were overdue for some kind of think there are plenty of opportunities one of the hardest. “You have to contain correction,” portfolio manager Tim to invest in companies that have the your emotions. It’s not easy to do on the Armour says. “I am not overly concerned potential to reward investors,” Tim says. way up, and it’s not easy to do on the about this pullback. Markets do way down, but it is the key to creating Volatility also reinforces the value of better over the long term when they wealth over time. Sticking with the diversifcation, and the role of bonds, experience corrections periodically; they fundamentals, employing good asset Mike Gitlin, head of fxed income, says. can’t go up all the time.” allocation and maintaining a balanced “Investors need to stay balanced in their portfolio with a long-term horizon is the Tim says that generally solid economic equity and fxed income weightings best approach.” data continues to provide a healthy in their portfolios, especially during backdrop for markets in much of the times like this. It’s important that world. In the United States, corporate investors focus on the four primary proft growth remains healthy, tax roles of fxed income in a balanced Key Takeaways reform could boost gross domestic portfolio: diversifcation from equities, • Markets periodically experience product (GDP) and consumer spending income, infation protection and capital corrections that are part of the is relatively strong. Following strong preservation.” investment environment. growth in 2017, the Canadian economy Some core bond strategies may not • The recent volatility has been jarring, remains in solid shape, and the provide the diversifcation from equities but the global economy is largely unemployment rate matches the lowest that investors expect, and that could be supportive of corporate earnings and level in decades. markets in much of the world. a problem in a correction. Abroad, China’s GDP accelerated for the • History shows that staying invested “That said, the current pullback may frst time in seven years in 2017, and the through periods of volatility has present a great opportunity for investors economies of other emerging markets rewarded long-term investors. to upgrade their bond portfolios: that continue to show strength. Japan’s

cover: A pedestrian navigates the rain- slicked streets of Chicago, Illinois. Bull vs. Bear: Long-term gain beats short-term pain The downside looks less daunting with a long-term perspective

“None of us can predict what Declines can be painful, but missing the upside could be worse the market is going to do in the short term. But what 700% Cumulative price return for each bull and bear market we can do is identify good companies that we think are AVERAGE 300 BULL 268% 70 growing and will be better MARKET Total Return Months and bigger companies 10

years from now. If we get 100 that right, through all sorts of market cycles, we are going to do well for our investors.” 0

tim armour –50 portfolio manager AVERAGE BEAR –33% 14 MARKET Total Return Months –75 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014 2018 Results calculated in U.S. dollars.

sources: Capital Group, RIMES and Swift and dramatic change can take a while the average 33% decline of these universe and a history of resilience Standard & Poor’s. Bear markets represent toll on investors. When markets falter, cycles can be painful to endure, missing during downturns. Investors should peak-to-trough price declines of 20% some may be inclined to reduce their out on part of the average bull market’s also re-examine their bond exposure or more in the S&P 500. Bull markets refect all other periods. Returns are exposure to equities. Yet history shows 268% return could be even worse. for excess risk, as diversifcation from shown on a logarithmic scale through that periods of turmoil and steep market The much shorter duration of bear equities is one of the primary roles of February 14, 2018. Past results are not declines have subsequently proven markets (14 months on average), is also fxed income in a balanced portfolio. predictive of results in future periods. to be among the best times to invest. a reason why trying to time investment Recent history, and the long-term record, Recent volatility may have caused some decisions can be diffcult and is usually show how rapidly the market can turn. investors to panic and head for the exits, ill-advised. Rather than indiscriminate The volatility of returns of the S&P 500 but a long-term focus can help put bear selling, investors who are nervous dating back about 60 years indicates that markets into perspective. Since 1949 about heightened volatility may want to investors may be doing real damage to there have been nine periods of 20%-or- consider objective-based funds with the their long-term fnances by trying to time greater declines in the S&P 500. And fexibility to invest in a broad investment the market.

THE LONG VIEW · 1 Why are some declines steeper? It’s the economy Some of the most severe declines are associated with recessions

“The U.S. economy has Short, and not that sharp: Since 1945, nearly half of the declines have lasted less than eight months been in an expansion for Decline in S&P 500 (%) a while now, but I think it –10

still has a ways to go. There Feb-1980 May-2015 Apr-2010 doesn’t appear to be Aug-1956 –20 Apr-2011 Sep-1976 anything systemic, or any Jul-1998 Jun-1990 Feb-1966 big imbalances, that we May-1946 Dec-1961 Nov-1980 think are of a signifcant size –30 and nature, that would push Aug-1987 the U.S. economy into a Dec-1968 –40 recession within the next No recession With recession 12 to 18 months.” Median decline –20.8% –31.5% Jan-1973 Mar-2000 darrell spence –50 Median duration 6 months 17 months economist Oct-2007 –60 0 5 10 15 20 25 30 35 40 Duration of decline (months) Results calculated in U.S. dollars.

sources: Capital Group and Standard & Every decline is different. A look back at the economy at the time. The median In relatively recent times, the fnancial Poor’s. Dates for declines shown represent stock market history since World War II decline in the S&P 500 during retreats crisis and the tech bust have both market peaks. Peak-to-trough dates are as follows: shows that retreats have varied widely in associated with a recession is 10.7% had signifcant impacts on investor May 1946 - June 1949, August 1956 - December intensity and length. But many declines greater than those not associated sentiment. Market crises are traumatic 1957, December 1961 - June 1962, February 1966 - October 1966, December 1968 - May during that period share a common with a recession, while the duration and costly. But ultimately, the market 1970, January 1973 - October 1974, September pattern. In fact, nearly half of the declines of the decline is substantially longer. has not only survived, but thrived. For 1976 - March 1978, February 1980 - March since 1945 lasted less than eight months. The reason? Earnings fall much more more than a century, the U.S. market has 1980, November 1980 - August 1982, August And, in nearly one-third, the market was dramatically around major pullbacks endured wars, recessions, assassinations, 1987 - December 1987, June 1990 - October 1990, July 1998 - August 1998, March 2000 back at a new high less than 10 months than around minor bear markets. Those bubbles and busts. And each time it has - October 2002, October 2007 - March 2009, after it peaked. One important factor declines in the lower centre of the chart come back. Through it all, the market April 2010 - July 2010, April 2011 - October in determining whether a decline is are among the most serious and have all has demonstrated a remarkable strength 2011 and May 2015 - February 2016. May major or minor is what’s happening in been associated with a recession. and resiliency in the face of challenges. 2015 is not an offcial decline. More severe declines are those associated with recessions beginning within 12 months of the market peak.

2 · THE LONG VIEW Some sectors can provide a measure of protection Security selection and diversifcation can play a role when markets retreat

“The recent volatility has served Index return doesn’t tell the whole story — some sectors have outpaced the market as a reminder that markets can and will change, so we’ll continue to take a measured, SECTOR SCORECARD Above S&P 500 Below S&P 500 Through seven declines, some sectors have long-term approach, with fnished above the overall market 1987 1990 1998 2000–2002 2007–2009 2010 2011 capital preservation very S&P 500 SECTOR –32.9 –18.7 –19.2 –47.4 –55.3 –15.6 –18.6 important in security selection ABOVE / BELOW CONSUMER STAPLES 7 0 and portfolio construction. I UTILITIES 7 0 believe that in this environment, HEALTH CARE 6 1 our ability to add value will TELECOM 6 1 come primarily through ENERGY 4 3 security selection backed by CONSUMER DISCRETIONARY 2 5 fundamental research.” FINANCIALS 2 5 INFORMATION TECHNOLOGY 2 5 hilda applbaum MATERIALS 2 5 portfolio manager, capital group INDUSTRIALS global balanced fundsm (canada) 1 6

Results calculated in U.S. dollars.

sources: Capital Group, FactSet, RIMES, During the fnancial crisis that jolted One of the consequences of the market’s The benefts of diversifcation may have Standard & Poor’s and Thomson Reuters. the markets a decade ago, there decline during the fnancial crisis was been lacking in 2008 and early 2009, Sector returns for 1987 are equally was nowhere to hide. From its peak that many investors questioned the but generally the principle remains weighted, using index constituents from 1989, the earliest available data set. on October 9, 2007, to its low on value of diversifcation. During periods fundamentally sound. Diversifcation March 9, 2009, the S&P 500 dropped of instability, however, it’s important through a strategic allocation to stocks 55.3%. Every sector in the index suffered to maintain perspective, balance and and bonds around the world remains a serious setback, with the fnancials fexibility. A portfolio that has the ability the hallmark of a portfolio that can help sector losing 81.7% of its value. But to nimbly explore evolving opportunity investors pursue their objectives in some sectors held up better than sets, using both allocation and security the long run. Such a portfolio can also others. Consumer staples, for example, selection, can add value by investing in help investors maintain a long-term retreated about 29%, while health care the right stocks and bonds based on a perspective and place short-term drivers dropped 38%. Small comfort, but still fundamental, valuation-based approach. of the market into perspective. relative outperformance.

THE LONG VIEW · 3 Buffers: Bonds can provide resilience when equities decline Bonds can help mitigate volatility and provide balance in a diversifed portfolio

“There are four roles of fxed Bonds have provided a measure of capital preservation in periods of market turbulence income in a diversifed portfolio: diversifcation from Cumulative returns (%) equities, income, infation 29.1 protection and capital Bloomberg preservation. Nowhere in Barclays U.S. Aggregate 7. 2 5.4 there does it say, ‘Try to be as Index 1.6 1.2 1.9 3.0 equity-like as possible.’ That’s S&P 500 not the ffth role.” Composite –15.6 Index –18.7 –19.2 –18.6 mike gitlin head of fixed income –32.9

–47.4 –55.3

1987 1990 1998 2000–2002 2007–2009 2010 2011 Results calculated in U.S. dollars.

sources: Bloomberg Index Services Bonds play a variety of roles in a The U.S. Federal Reserve raised interest The ability to provide resilience in Ltd., RIMES and Standard & Poor’s. diversifed portfolio, including providing rates three times in 2017 and once in periods of equity market corrections income, capital preservation and 2018 to a range between 1.5% and should be one of the goals of short-, infation protection. They also help 1.75%. Looking ahead, the U.S. Fed is intermediate- and core-bond strategies. mitigate volatility. When equities are expected to raise rates several times Funds that provide diversifcation from volatile, bonds typically provide balance in 2018, but the Fed has indicated that equities can be good building blocks to a portfolio. The chart shows that in rate hikes will be gradual, which can to help create durable portfolios. They market declines of at least 15% during moderate the impact on the value of also allow investors to rebalance their the past three decades, bonds have bonds. Investors who take a broadly asset allocation at an appropriate time provided relatively signifcant positive diversifed approach in their fxed in market cycles. This approach can help returns. That’s one of the reasons to income allocation and avoid excessive investors achieve long-term investment invest in bonds, even in a rising rate credit risk shouldn’t feel a dramatic and savings goals. environment. impact from U.S. Fed policy.

4 · THE LONG VIEW Long-term investors have weathered market declines Don’t let intrayear declines derail long-term investments

“We’ve recently been through Avoid the urge to time the market a volatile and, in some ways, surprising period. When we 8080%% HypotheticalHypothetical initial initial investment investment EndingEnding value value US$50,000$50,000 go through times like this, it’s US$10,000$10,000 US$40,135$40,135 easy to respond by focusing 6060 40,00040,000 on the short term. But I think CalendarCalendar year year price price returns returns the right thing to do in such an 4040 30,00030,000 environment is to push your time horizon. You need to be 2020 20,00020,000 thinking for the long run.” 00 10,00010,000

carl kawaja portfolio manager, capital group –20–20 00 global equity fundsm (canada) LargestLargest intrayear intrayear decline decline

–40–40 –10,000–10,000

–60–60 –20,000–20,000 19971997 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 Results calculated in U.S. dollars.

source: Capital Group. Intrayear gain and Declines happen, and it’s not easy rising market because they worry that a grown to an ending value of more than decline refect largest price changes within to keep calm and carry on. Indeed, correction might occur. US$40,000 as of December 31, 2017. each year. S&P 500 annual returns are based there is a natural human instinct to During the past several years, the world’s on the price index only and, as such, exclude And the market provides plenty of make changes, including portfolio equity markets have demonstrated a dividends. The index is unmanaged and, opportunity to make changes. The S&P adjustments, based on what one thinks very low level of volatility. Volatility could therefore, has no expenses. Investors cannot 500 has had intrayear declines every invest directly in an index. Past results are will happen. This impulse isn’t confned be returning to more normal levels, year for the last 20 years. But while the not predictive of results in future periods. to periods when stock prices are falling which can represent an opportunity for market has its declines, it also goes up. This hypothetical illustration is for — it’s equally tempting when stocks are long-term investors with a systematic Overall, the market has gone up 16 out informational purposes only and is not rising. Just as some investors are inclined investing plan. Regular investing does intended to provide tax, legal or fnancial of 20 calendar years since 1997. As a to reduce equity exposure following a not ensure a proft or protect against advice. For illustrative purposes only; please result, a hypothetical initial investment market decline, others are reluctant to losses. Investors should consider their consult your fnancial and/or tax advisors of US$10,000 in the stock market, as regarding your individual situation. maintain stock investments during a willingness to keep investing when share represented by the S&P 500, would have prices are declining.

THE LONG VIEW · 5 Years of experience as of December 31, 2017. 31, December of as experience of Years holds abachelor’s degree ineconomicsfrom MiddleburyCollege. Tim isbasedinLos Angeles. service companies. Tim beganhiscareer at Capital in asaparticipant The Associates Program. He Chartered Financial Analyst® designation. HildaisbasedinSanFrancisco. from Barnard Columbia College Universitygraduating of magnacumlaude. Shealsoholdsthe master’s degree ineconomicsfrom New York Universityandabachelor’s degree ineconomics analyst andeconomistat Federal Farm Credit Banks Funding Corp. inNew York. Hildaholdsa under licence. NeitherBloomberg norBarclays (collectively with its affliates, “Barclays”), used Barclays® Barclays isatrademark BankPlc of L.P. (collectivelywith itsaffliates, “Bloomberg”). Bloomberg® Bloomberg isatrademark Finance of Indices LLC. S&PDow Jones without writtenpermissionof or reproduction are inwholeorpart prohibited or its affliates. All rights reserved. Redistribution Jones IndicesLLC, S&PGlobal, adivisionof and/ use byCapital Group. Copyright ©2018 S&PDow LLC and/oritsaffliates andhasbeenlicensedfor The S&P S&P500isaproduct of Dow Jones Indices not berepeated. frequently may andpastperformance not guaranteed, theirvalueschange tus before investing. Mutualfundsare investments. Please read the prospec may beassociated withmutualfund management feesandexpenses all Commissions, trailing commissions, Investment professional biographies manager of Capital Groupmanager of GlobalBalancedFund Hilda L. Applbaum investment analystat Capital, hecovered globaltelecommunications andU.S. investmentexperience,of allwithCapital Group. Earlierinhiscareer, asanequity Management Committee. manager. Heisalsoanequityportfolio Tim has35years Company, Inc., Capital theCapital Group; of part Group andchairmanof chairman andprincipalexecutive Capital offcer Research of andManagement Timothy D. Armour researchof forthe California Public EmployeesRetirement System, andaresearch securities. Before joiningCapital, shewasaprincipalinvestmentoffcer anddirector career, asanequityinvestmentanalystat Capital, Hildacovered globalconvertible investment experience andhasbeenwithCapital Group for23years. Earlierinher is a portfolio manageratis aportfolio Capital Group andaportfolio is chairman and chief executive Capital offceris chairmanandchief Group; of - Additionally, in The Capital System not tobecomprehensive ortoprovide advice. This information isintendedtohighlight issuesand affliates. its or Group Capital of opinions the refect thedate published anddonotnecessarily as of individual represent that individual theopinionsof or otherconditions. Statements attributed to an subject tochangeat anytimebasedonmarket opinions, speak onlytothestated period, andare The statements expressed herein are informed advice norasarecommendation tobuyorsell. anyinvestmentfunds,trading intentof investment sector shouldnotbeconsidered anindication of company,a particular security, industryormarket ment byCapital Group. Views expressed regarding only andshouldnotbeconsidered asanendorse included forinformational orillustrative purposes References to particular companies or securities are injury ordamagesarisinginconnectiontherewith. neither shallhaveanyliabilityorresponsibility for herein and, tothemaximumextent allowed bylaw, anyinformation the accuracy orcompletenessof approves orendorsesthis material, guarantees SM (Canada). Shehas31years of SM , differences of - graduating magnacumlaude. Carl isbasedinSanFrancisco. fnance from Columbia Business School andabachelor’s degree inhistory from Brown University New York, aswellanequityanalystforLévesque Beaubien inMontreal. HeholdsanMBA in cash equities. HealsoservedasheadAsia-Pacifc of trading forCredit Suisse Asset Management as headAsia-Pacifc of salestrading, headAsia-Pacifc of cashequities, international andhead of Before that, U.S. hewashead of equitysalesforCitigroup GlobalMarkets, where healsoserved degree from Colgate University, graduating cumlaude. Mike isbased inLos Angeles. and traded Japanese equitiesand bondsforGeorge Weiss and Associates. Heholdsabachelor’s Group’s Canadian mutualfunds. professionals featured donotmanageCapital Unless otherwiseindicated, theinvestment other time. represent thespeakers’ opinionsandbeliefsat any commentary wasmadeandare notintended to thespeakersand beliefsof expressed whenthe The statements in The Long View are theopinions undue reliance onforward-looking statements. ment decisionsandweurge youtoavoidplacing other factorscarefully before makinganyinvest herein. We encourage youtoconsidertheseand implied inanyforward-looking statements made could differ materially from thoseexpressed or future performance, andactualeventsresults Forward-looking statements are notguarantees of otherinvestmentprofessionals. views of by anindividualdonotnecessarilyrefect the opinion are common, and the opinions expressed the head of fxed incomeat the head of T. Rowe Price, trading. andearlier itsglobalhead of and hasbeenwithCapital Group forthree years. Prior tojoiningCapital, Mike was Group ManagementCommittee. investmentindustryexperience Hehas24years of theFixedchair of IncomeManagementCommittee andalsoservesontheCapital Group, withprimaryresponsibility forleading thefxed incomebusiness. Heis Michael C. Gitlin Business Economics. Darrell isbasedinLos Angeles. Financial theNational Analyst® designation andisamemberof Association for PhiBetaKappa andOmicronmember of DeltaEpsilon. HealsoholdstheChartered honours ineconomicsfrom OccidentalCollege graduating cumlaude, andisa industry experience, allwithCapital Group. Heholdsabachelor’s degree with Darrell R. Spence Before joiningCapital, Carl wasasecurityanalystforGabelli&Company in products andU.S. personalcare companies, alongwithCanadian companies. career, asanequityinvestmentanalystat Capital, hecovered globalhousehold investment experience andhasbeenwithCapital Group for26years. Earlierinhis manager of Capital Groupmanager of GlobalEquityFund Carl M. Kawaja is an equity portfolio manageratis anequityportfolio Capital Group andaportfolio is a partner at isapartner Capital Fixed IncomeInvestors, Capital of part is aneconomistat Capital Group. investment Hehas25years of - the three equity investment groups. one of characteristics, of theyactsolelyonbehalf organization; however, for securitieswithequity and investmentmanagement across theCapital ment professionals provide fxed incomeresearch decisions independently. Fixed incomeinvest These groups make investment andproxy voting equity assetsthrough three investmentgroups. in 1931. The Capital Group companiesmanage ment frmoriginating inLos Angeles, California Capital Group, aglobalinvestmentmanage Asset Management(Canada), Inc. are of part Capital Group fundsandCapital International fnancial andtaxadvisors. For yourindividualsituation, please consult your available inCanada through registered dealers. be subjecttochange. Capital Group fundsare has beensuppliedwithoutverifcation andmay reliance thereon. The information containedherein plete information, norforanyactionstaken in no liabilityforanyinaccurate, delayedorincom provide tax, legalorfnancialadvice. We assume For informational purposesonly;notintendedto SM (Canada). Carl has31years of - - -