3rd Quarter Client Note

Markets continued to move higher in the 3rd quarter. The S & P 500 (total return) index was up 3.85% and 8.12% year-to-date. The small cap Russell 2000 index increased 9.05%. Foreign markets, which have underperformed significantly over the last decade, were among the best performers. The MSCI Developed Markets Index was up 6.43%; while the MSCI Emerging Markets Index gained 9.03%. Real estate, which has been one of the best performers since the 2008 recession, returned negative 1.24%.

At its September meeting the Fed decided to maintain interest rates where they are. But the bond market is nevertheless expecting the Fed to act sooner than later. The yield on the 10-year Treasury note increased 11bps. And the Barclays US Aggregate Bond Index increased by a modest .46%.

Are You Now or Have You Ever Been a Communist?

For as long as I have been an investor and an adviser, I have been a strong adherent of so-called “passive” or evidenced-based investing. We endeavor to capture the expected returns of the market and avoid the largely fruitless attempts to beat the market undertaken by active investors; who try to pick the winning stocks or time the market’s ups and downs.

One of the more amusing events of the quarter was the publication of a note by AllianceBernstein (not coincidentally a purveyor of active strategies) entitled The Silent Road to Serfdom: Why Passive Investing is Worse than MarxismFirst, they complain that passive investing isn’t discerning enough to direct capital toward opportunities and away from trouble. And then they erect the perennial straw man: What if everyone were a passive investor? Wouldn’t the markets collapse?

Well, yes they would. But we’re not even close to that point. Vanguard estimates that only 5 – 10% of total trading volume comes from index funds. And it’s probably impossible, anyway. As we were to get closer to such a point, markets would become obviously less efficient. Spreads would widen and the arbitrageurs would come out of the woodwork.

So, take the advice of AQR’s Cliff Asness in his brilliant rejoinder Indexing is Capitalism at its BestAnd feel free to piggy back on the setting of stock prices by others – as you would with air conditioners – and focus your investment strategies and financial planning on the things you can control.

Elephant in the Room

We are about to experience one of the most unusual and extraordinary presidential elections in history. There is only a month to go. And tensions will undoubtedly increase as Election Day approaches. By all means, watch the debates, talk politics with your friends and family and remember to vote. But whatever you do, please don’t try to “position” your portfolio for the outcome of the election. That would likely be a fool’s errand.

There is recent precedent. Around the time of the June 24th UK citizens’ referendum on the “Brexit” there was considerable market anxiety and volatility. But, within a few weeks of the vote the FTSE 100 hit 11-month highs and by July, the S & P 500 hit an all-time high. Great Britain still has difficult political and economic issues to work out – as will the US, regardless of who wins the election. But basing an investment strategy on this kind of short term speculation is counterproductive. It is far better to diversify broadly and stay focused on your long term goals.

Even if you knew in advance the outcome of the election it wouldn’t help you with your long term strategy. Nobody knows what the market is going to do in the short or intermediate terms. Not you. Not me. And least of all, the “pundits” on TV. Current prices reflect all the available information and everyone’s collective opinion.

Our friends at Dimensional Funds Advisors, on the last two pages of their Quarterly Market Review, provide us with a cogent history of stock market performance as it relates to presidential elections. The first exhibit shows the monthly returns during which a presidential election was held compared with all other monthly returns. And shows that such returns are well within the range of randomly normal; regardless of which party wins. The second chart (entitled Bulls & Bears does not equal Donkeys and Elephants) shows that the administrations of neither party are obviously better for the market.

So just hang on to your hat. Regardless of what color it is.

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