Staying Diversified Through Volatile Markets
By Rob Wrubel, CFP®, AIF®
From end to end (and from a few weeks perspective) last year looked fairly benign to US investors. The S&P finished positive, bonds continued to perform well, inflation did not surge and the economy chugged along at a decent rate.
As we remember, the story beneath the surface did not look so smooth. According to Yahoo Finance, the S&P 500 closed on October 3, 2011 at 1,099.23. It had been at 1,363.61 on April 29, 2011. The return from the high to the low of the year was down close to 20%. The return from that low moment to the end of the year was about 17%. In October, it looked like the markets were going to get worse by the day, not better, and many investors kept leaving the markets in search of lower volatility and perceived safety in cash and bonds.
Headline risk had us believe in the end of the Euro, the devastation of American manufacturing, the end of the growth story in China and a complete stoppage of the economies here and abroad.
What a year. As it turned out, none of those screaming headlines proved to be true. And many investment categories had positive returns even with the volatility.
U.S. equities ended the year up 2.11%. U.S. fixed income (bonds) ended up 7.84%. Cash and money market effectively earned zero (with some small amount of interest). The real negatives were in developed international markets – down 14.82% – and emerging markets – down 20.41%. Commodities in general also had negative returns.*
How should we react to this as investors? How is it possible to maintain a steady course in the face of turbulent markets? The winds changed swiftly last year and many investors sought shelter in money market funds as a way to avoid them. Those that chose to exit equities in July, August and September gave up any chance to see their portfolios recover, most likely locking in significant losses. Those that forged ahead in face of the stiff winds had returns somewhere in a range of a few percent above or below zero. The key drivers were the extent to which funds were invested in international equities and commodities.
One question stood out last year as we discussed portfolios with our clients: “Why do we invest in international markets at all?” So many people were frustrated with the fact that the European debt crisis was playing such a big role in their portfolios and we see from the returns above that last year was an awful year in general for investments in foreign countries.
A look back at the last ten years provides some degree of understanding. We invest throughout the globe to diversify portfolios. US companies perform better than their international counterparts at times, and they underperform at times. In 2003, the MSCI EAFE Index (the index of developed countries – EAFE means Europe, Australia and the Far East) – gained 39.17% versus the S&P 500 which earned 29.11%.** Last year, the EAFE index underperformed the S&P 500.
The question of why own Europe has a multi-part answer.
We do not have any way to predict which years will see outperformance of one asset class by another. We do not have any way to predict, right now, when the slide in confidence in Europe will stop. We build portfolios that include a variety of assets classes, all of which will fluctuate on any given day, that have shown strong potential for returns over time.
Close to like two-thirds of the world’s economy is outside the United States. We tend to focus on our own country and companies in looking at investments. It is easier to understand why we should invest in Coca-Cola, GE or Apple as we feel and see their products every day (especially if you ever turn on the TV or radio). The rest of the world also has its share of name-brands – like Sony, BMW and Nokia. Overseas markets are filled with hungry entrepreneurial public companies that do not have a presence in the US. Many of these are classic growth stories that compare with companies here but serve their home markets. By investing overseas, we have the chance to participate in the growth and profits of multiple markets. Sometimes, these markets move with ours, other times not. Either way, we want to participate as investors.
Right now, we want to stay invested in the developed market funds even those with significant exposure to Europe. Prices have already fallen. The markets are down. Price to earnings multiples seem reasonable. We do not know if this means that the buyers will enter here and scoop up stocks at what look to be discounts. Stocks in Europe and elsewhere could still go down more as Europe is essentially in a recession now and uncertainty is high.
That being said, market change for the positive could come at any time. Remember, the US markets looked to be falling apart and broken in January and February 2009. We were still in the middle of the housing and bank crisis. The Fed has not yet restored confidence through its programs that stabilized the banks and kept money circulating through the economy. In March of 2009, the market moved sharply upward. We stood below 700 on the S&P 500 and now have reached just over 1,315 (as of market close January 20, 2012). The move was sharp, swift and restored significant value to portfolios.
We do not know when markets will change. We believe in building portfolios with multiple asset classes and rebalancing those portfolios on a regular basis. This forces us to buy more of those asset classes that have not done well over the past year and sell some of the ones that have done well. This would have worked well in 2008 leading in to 2009. It would have worked well in the lead-up to the tech bubble in the earlier part of the last decade.
2012 has started well. The major indices have seen gains so far. Like last year, the markets are off with a jump. The past two years have seen dramatic swings in the summer. We look forward to keeping your portfolios allocated according to your plans and looking for opportunities when we think they appear.
Rob Wrubel is a Senior Investment Consultant with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.
*Return information supplied by Morningstar. U.S. equities measured by the S&P 500 index, fixed income measured by the Barclay’s Aggregate bond index, developed international by the MSCI EAFE index and emerging markets by the MSCI Emerging Markets index. All indices are non-managed portfolios that cannot be invested in directly.
** Return information supplied by Thornburg Securities Corp.
