This year’s market movements are not unexpected nor are they out of the ordinary. The S&P 500’s average return is about 10% with an average drawdown of 14% sometime during the year. Many pundits called for a correction (stock market drop of 10% or more) this year and were lauded for this supposedly bold stance. History tells us to expect a drawdown of 14% each year and this year we got one of 12%. Again, this is not unexpected. We should only be surprised if there isn’t a sizable drawdown during the year. I admit, it would be highly entertaining if we had a panic button we could hit here in the office that set off klaxons and red strobe lights in the event of market emergencies. Unfortunately, that button would be largely unused. Negative returns are part of a normal market and we are a long way from hitting the panic button.
The real story is that diversified portfolios have lagged recently. This was highlighted in the Harvard Endowment’s latest investment report. Over the last 1, 5, 10, and 20 years a global portfolio (one including US, Developed International, and Emerging Markets securities) of 60% stocks and 40% bonds lagged one made up of strictly US securities. Of course the situation would have been reversed in a year like 2007 when international stocks outperformed the US by a wide margin. The risk in reacting to a snapshot of data like this is that an investor would be chasing returns, switching from one allocation to another at the worst possible time. Sticking with a diversified portfolio allows an investor to sell high and buy low – the opposite of return-chasing.
International stocks have had a difficult year. From a portfolio construction standpoint international stocks do add value over time, but there are other reasons to be optimistic about the asset class. Europe is a couple of years behind the US in recovering from the global financial crisis. The systemic risks have been managed, setting the stage for recovery. Japan is also exercising its monetary policy muscles while implementing shareholder-friendly reforms to its stock market. JP Morgan’s analysts point out that when the Emerging Markets trade at under 1.5 times book value it is usually a good time to buy. They are also quick to mention that they have traded that low for the last two years so market timers have gotten burned.
You’ll note that the 19th hole on this month’s Scorecard (you DO click on that, don’t you?) is a quote from Yogi Berra: You’ve got to be very careful if you don’t know where you’re going because you might not get there. Berra had a gift for tying the absurd into reality. As goofy as the quote sounds on its face, there is real meaning there. From an investor’s perspective, it means you have to identify what your financial goals are and put a plan in place to achieve those goals. Otherwise, you’ll likely wind up unsatisfied, unsure of how well you should be doing, with the only certainty being that you feel like you should have more.