Our Chief Investment Officer, Eric Cramer, gives a brief overview of what to expect for the Q4 2017 Market Reports.
Thanks for listening today. Please join us for one of several upcoming BIP Q4 2017 Market Report presentations.
QUARTERLY MARKET REPORT LUNCHES
OCTOBER 26 AT 12:00PM
OCTOBER 31 AT 12:00PM
NOVEMBER 2 AT 12:00PM
OCTOBER 25 AT 12:00PM
NOVEMBER 1 AT 12:00PM
NOVEMBER 7 AT 12:00PM
QUARTERLY MARKET REPORT WEBINAR
The third quarter of 2017 was yet another terrific period for stock market investors. Our global equity benchmark, the MSCI ACWI IMI Net index, was up 5.32% for the third quarter, bringing the year-to-date performance through September 30th up to 17.24%. Now the question on the mind of most investors we speak with is simply “can this rally continue?”
Excessive stock market returns in 2017 have been a pleasant surprise for investors, but this rosy situation has damaged the reputations of the legions of professional stock market commentators who started the year with predictions that ranged from cautionary to highly pessimistic. In our Quarterly Market Report for Q4 we will dissect the market’s recent behavior and explore the economic influences that could sustain, or derail, the recent rally.
The three-year average annual return through September 30th for the global equity index mentioned before is only 7.72%, while the fixed income index averaged only 2.71%. These annual averages are about what we expect to see over the next twenty years, and are far below what we’ve seen so far in 2017. That gap should remind us that investment returns are rarely near their averages over any one-year period.
Stated another way, a significant portion of your gains (and losses) happen over very brief periods of time. This is why experienced investors are reluctant to expose themselves to the additional risks of market timing. The burden of getting such timing right is enormous, and if that is your strategy it will be impossible to calculate the probability of meeting your long-term financial planning goals. It is certainly possible for an investor who jumps in and out of the market repeatedly to experience significant losses while avoiding gains. Experienced professionals in this industry can usually tell stories of watching investors do this to themselves when fear, impulsiveness, and bad luck are combined.
One motivation for market timing is greed. We would all like to experience the upside of investing, but wouldn’t it be nice if we could get this while somehow avoiding losses. We might call that “having our cake and eating it too”, and while this can sometimes happen for a few lucky investors, there is a massive amount of academic literature to explain why this is simply a random occurrence. From a statistical standpoint, it’s easy enough to review the returns of the thousands of firms that attempt to engineer this each year. Most fail in any given year, and nearly all fail eventually. The few winners over any short period of time are just as likely to fail in the future. But greed makes some people extremely susceptible to the false promise of high returns with an escape hatch.
Another motivation for market timing is fear. For some investors, the default investment is cash, and exposure to the stock market comes in brief intense spurts of bravado that collapse with every piece of bad news. The results of this type of investing experiment are predictable enough, but we have been operating in a low interest rate environment for so long now that cash investors have actually lost money to inflation. Over the last decade, inflation has run at least a percent higher than the return on cash (depending on which measures you use). The result is that risk averse investors have been guaranteed to lose money once the inflation adjustment is made.
And that takes us into the realm of predicting whether or not the recent stock market rally has legs. Overall the U.S. economy is looking OK, and the International Monetary Fund just raised global economic growth expectations by a smidge. Longer term trends of a growing global consumer class suggest that capitalism is on the rise and that equity owners will be rewarded. It’s becoming harder and harder to find any bad economic news to talk about. We will cover all that data in our upcoming Quarterly Market report.
The big problem on many economists’ minds in the short-term, however, is that the U.S. Federal Reserve is very concerned about elevated asset prices (translation: they aren’t happy with such a big stock market rally). In June of this year, Janet Yellen commented that asset valuations are “somewhat rich if you use some traditional metrics like price earnings ratios.” The idea is that this concern by the Fed might cause them to raise interest rates faster than they would if their only concern was their official mandate of full employment, low inflation, and moderate long-term interest rates.
Some of you may remember back to when Alan Greenspan posed the question of whether “irrational exuberance” had unduly escalated asset values. That was on December 5, 1996, and it was a question, not an emphatic statement of his opinion. The Federal Funds target rate was 5.25% then, and was raised and lowered a few times before hitting a high of 6.5% on May 16, 2000. In hindsight, this set the stage for the stock market peak in August, 2000. The point is that the market rose for three and half more years before any serious decline occurred. A disciplined investing strategy that took moderate risk, and was rebalanced regularly to take profits from a rising equity market, faired pretty well.
Perhaps it might be useful to take a step back from all the intense analysis on interest rates and economic expansion and instead focus on other risks to the market, the so-called “shocks” that we can never be fully imagined in advance. I like to talk about asteroids as my favorite example. But we must recognize that war, cyber-attacks, natural disasters, and even bad governance, all have the ability to wipe out years of returns in just a few days.
The realization that unforeseen events may pose just as big a risk to portfolio values as interest rates, or the rate of GDP growth, is critical to the exercise of risk management. The key concepts here are that risk budgeting should occur in advance of a crisis, and that markets can go up for years after warning signs are first detected. It’s easy to look back and see the warning signs that predicted a big market drop. But the reality is that you may hear hundreds of warnings for years before the market drops. The obligation of the investor then is to stick to a plan, and to react effectively after the crisis to turn lower prices into a buying opportunity.
Thanks for listening today. This is Eric Cramer, Chief Investment Officer at Buckhead Investment Partners. Goodbye for now and I look forward to seeing you at one of our upcoming Quarterly Market Report lunches, or on the webcast.
Disclosure: This communication contains general investing information that is not suitable for everyone and is subject to change without notice. Past performance is no guarantee of future results and there is no guarantee that any views and opinions expressed will come to pass. The information contained herein should not be construed as personalized investment advice, tax advice, or financial planning advice, and should not be considered a solicitation to buy or sell any security. Investing in the stock market and the bond market involves gains and losses and may not be suitable for all investors. The Global Equity index is the MSCI ACWI IMI Index, which is a free float-adjusted market capitalization weighted global index selected as the best available proxy for a diversified stock portfolio consistent with modern portfolio theory. Approximately 55% of the index is comprised of the U.S. stock market and 45% is comprised of international stock markets, including both developed and emerging countries. The “Net Total Return” version of the index is reported here, which means the index reinvests dividends after the deduction of withholding taxes, using a tax rate applicable to non‐resident institutional investors who do not benefit from double taxation treaties. The U.S. Fixed Income index is the Bloomberg Barclays Capital U.S. Aggregate Bond Index, which is a broad-based benchmark selected as the best available proxy for a high quality, diversified fixed income portfolio suitable for a U.S. investor. It is comprised of the Barclays Capital U.S. Government/Credit Bond Index, the Mortgage-Backed Securities Indices, and the Asset-Backed Securities Index. It is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, with maturities of at least one year, and an outstanding par value of at least $100 million. The “Total Return” version of the index is reported here, which means that dividends are included and reinvested. It is not possible to invest directly in this or any other index.