State of the Markets
Through the first quarter of 2013, with the U.S. election and fiscal cliff behind us and only minor rumblings from Europe, global equity markets added to the significant gains of last year. In contrast to 2012, when global stock markets marched in lockstep, 2013 has produced a broader range of asset class returns (which can be seen in the table and chart below). Global equity markets were up overall with U.S. stocks leading the way, while emerging market’s stocks (as measured by the MSCI EM Index) were slightly negative.
This dispersion in stock market returns is, in part, a reflection of the dispersion of current economic activity. The U.S. economy is slowly trudging along; Europe is falling back into a (hopefully) mild recession; while emerging market economies are slowing down from a previously torrid pace and may be hurt the hardest by a slowing global economy.
Meanwhile, the U.S. bond market, digesting an uptick in interest rates, turned in a marginally negative return. The total returns for major asset classes are below.
As mentioned above, there has been a divergence in the returns of asset classes over the past quarter. We would prefer if everything we own increased in value all the time, but markets ebb and flow. The nature of diversification is to use these ebbs and flows to our advantage to dampen the overall volatility of a portfolio, while sacrificing as little return as possible over the long haul.
Our style of investing relies on three principal means of diversification to add long-term value to the investment process.
A blend of growth and stability: This is the primary relationship between stocks and bonds. It allows us to dial in a risk and return profile that suits client preferences.
A global perspective: Global diversification of equity exposure (and into other equity-like assets) is acknowledgement that there is opportunity outside U.S. borders. It provides exposure to foreign companies, foreign currencies, and alternative capital structures (such as REITs and MLPs), and does so in rational proportion.
Additional dimensions of return: In equity markets around the world, historically, value stocks have outperformed growth stocks and small companies have outperformed large companies*. These performance advantages can be meaningful, but they don’t show up every year, and patience has been needed at times. As the chart below displays, through Q1 small cap stocks are leading large cap stocks both domestically and internationally. This differential can have a meaningful impact on performance if fully captured.
New Market Highs, What Does It Mean?
After steadily trending upwards through the first quarter, both the Dow Jones Industrial Average and the S&P 500 marked all-time closing highs in early April. Is this good news, bad news, the start of a new era, or a time to take profits?
We think none of the above.
Like you, we are happy when markets are up. We like to see progress in the portfolios we manage, but we don’t follow the market hour by hour, or day to day (and suggest you don’t either).
Stock market levels and valuations are ultimately a reflection of the current reality of the underlying companies. Sometimes this reflection is warped through incredibly optimistic (1999) or pessimistic (2009) lenses, but mostly it accurately represents the fundimentals of the underlying companies. Right now those fundamentals are good. With corporate earnings at all-time highs, it is no surprise that stock prices are setting records as well.
We feel expected returns going forward will be reasonable but not remarkable. We also know that those returns won’t be delivered in a straight line. Declines are inevitable. Investors should be prepared to weather the declines, participate in the recoveries, and set realistic expectations, in order to get desired results.
Welcome Back, We’ve Kept Your Seat Warm
Below is a headline from a Financial Times article written in January 2013.
US retail investors return to equities
This article is one of many stories – anecdotal and otherwise – documenting the market timing follies of small investors who tend to be driven by emotion rather than strategy.
Investing over the last five, ten, or fifteen years has tested everyone’s patience, but staying the course has proved to be a winning strategy. If you have invested your assets in a disciplined, diversified manner designed to meet your financial planning needs, AND you have stayed the course through one of the most difficult investment periods of the last 100 years (when many did not), than apparently you are the exception rather than the rule.
*Based on historical asset class data. Details available on request.