2nd Quarter Client Note

The stock market continued its extraordinary rally off the 2009 Great Recession lows, shaking off an actual 2.9% fall in GDP and a sharp increase in sectarian violence in Iraq. Stocks, bonds and commodities all rose in the first half of 2014; the first time that has happened since 1993. The S & P 500 (total return) Index gained 5.21% and is up 7.87% for the year. International markets were up as well, with the MSCI EAFE (developed markets) Index gaining 4.4% and emerging markets rising 5.06%.

The bond market continues to surprise, with the long awaited rate increase…still waiting. The benchmark 10 – year U.S. Treasury note fell from a rate of 3.00% on December 31, 2013 to 2.53% on June 30 – resulting in a total return for the Barclays US Aggregate Bond Index of 1.93% for the quarter and 3.69% year to date.

Utilities (usually the province of widows and orphans) led all sectors with a gain of 8% for the quarter and nearly 16% for the year – driven largely by the fall in interest rates.

Preparing for a Correction

Economist Herbert Stein (father of Ferris Bueller’s economics teacher Ben Stein) famously said, “If something cannot go on forever, it will stop.” That certainly applies to stock market rallies.  But it is impossible to forecast when the correction will occur or what will be its cause.

The current rally (now in its sixth year) has charted a course between indifference and complacency. Individual investors have remained scared. Only in the past year have inflows into equity mutual funds become steadily positive – between zero and $20 billion per month.  S & P Capital has called this “the most unloved” bull market in history.

On the other hand, valuations are surely stretched, with the market P/E increasing from a 2009 low (in the single digits) to the mid-20’s today. The average is around 15.  But the CBOE Volatility Index (VIX) is at its lowest first- half level since 2007, reflecting a “what-me-worry” attitude.

Great arguments for keeping and maintaining a balanced portfolio.

Something unforeseen will undoubtedly trigger the next correction. But this quarter’s Quarterly Market Review from Dimensional Funds Advisors discusses the dangers to investors of trying to causally link news events to market moves. For example: “Dow falls on release of GDP data.”  While journalists get paid for writing such stories, trying to “connect the dots” can be disastrous for investors. Better to examine the evidence of what drives returns over long periods of time and apply that evidence to your investment strategy.

Examining the Evidence

Practitioners of the investing discipline we espouse around here have struggled with finding the right terminology to describe it. Sometimes we call it “passive” vs. “active.” Others like the “strategic” vs. “tactical” dischotomy. There is a growing movement to refer to our philosophy as “evidenced based” investing, based on scientific principles developed by peer-reviewed academic inquiry into how capital markets actually work. One of the unsung heroes of evidence based investing, Nobel laureate William F. Sharpe, was recently interviewed by our British friends at sensibleinvesting.tv on the subject of his Capital Asset Pricing Model and the conclusion that indexing is the most efficient and effective investment strategy. The interview is short and worth the read.

And for readers who still believe in the viability of identifying active managers who can consistently outperform their benchmarks, S & P Dow Jones delivers the bad news in its recent Persistence Scorecard. “Out of the 687 funds that were in the top quartile as of March 2012, only 3.78% managed to stay there by the end of March 2014. Further, 1.90% of the large-cap funds, 3.16% of the mid-cap funds and 4.11% of the small-cap funds remain in the top quartile.”

Fifty years later, Professor Sharpe is still on target.

 

Right Path Investments Logo

Before you go...

Join our newsletter to stay in touch with the financial world and get information to help plan your retirement.

"*" indicates required fields

This field is for validation purposes and should be left unchanged.