Predictably Unpredictable

1Q 2012

While our role as your trusted advisor calls for delivery of an “expert” opinion, we’ve used this venue in the past to highlight the fallacy of near-term market prognostication. Entering 2012, many prominent industry professionals and investors alike had settled on a “muddle through” scenario, in which a multitude of macro concerns were being weighed against a backdrop of fairly attractive valuations. With the benefit of hindsight, we can now confirm that first quarter results varied dramatically (in a good way) from the consensus expectation.

Expanding upon this idea of financial markets being predictably unpredictable, we’ll use the next few paragraphs to describe the recent and historic performance of the various asset classes we track and/ or include in our client portfolios. By illustrating this broad array of returns, we seek to reinforce how successful diversification means that at any given time some investments will be doing well while others do poorly.

Top-to-Bottom Spread: The best performing asset class for the quarter was Int’l Small Caps (+14.9%), which outperformed the worst performing asset class (Long Treasuries) by 21.6%. While this degree of separation over a 90-day period may seem unusually high, the top-to-bottom quarterly spread over the previous 10-years has ranged anywhere from 6.5% to 46.8%.

Best and Worst Performers: In our analysis of the past decade, we also discovered how all 18 asset classes spent at least one quarter as a top three performer (most frequently Emerging Markets stocks) and how 17 of these (all but High Yield Bonds) experienced a dip into the ranks of bottom three. Interestingly, over a third of the asset classes have been both best and worst overall performers in distinct quarterly periods.

Analysis of Cash: Since the recent financial crisis, many investors have downgraded themselves to “savers” by cowering in cash – $7.5 trillion to be exact – as they wait for the dust to settle. Despite its association with safety, cash has ranked as a bottom three performer 25% of the time and is the only asset whose return trails inflation for the past 10-years.

As we now move forward into the remainder of the year, this data can be helpful for managing expectations. Much has been written about the S&P 500 Index, which at +12.6% just turned in its best first quarter since 1998. When combined with the impressive +11.8% rally to conclude last year, we’ve seen the primary benchmark for large domestic stocks appreciate at an annualized rate of nearly 60% for two consecutive quarters. While nothing in the historical data or present fundamentals support this ongoing rate of growth, it’s simply part of the ebb and flow that’s to be experienced by the committed investor.

To conclude, we would sincerely advise clients not to succumb to overblown predictions, either ones that are too rosy or ones that are too pessimistic. Acknowledging the omnipresent global and geopolitical risks, find comfort in the market’s historic ability to discount potential outcomes and arrive at acceptable resolutions in due time. But most of all, take the emotions out of it. Although corrections will happen, more money is lost trying to anticipate a correction than is actually lost in a correction. Staying disciplined to the asset allocation described in your investment plan is vital. BAMG helps ensure this through periodic monitoring and rebalancing. We’re also continually striving to enhance the long-term durability of client portfolios by introducing complementary holdings when deemed appropriate. We will go through storms, but will also experience the new high and dry ground of recoveries, such as that of 1Q-2012, when the world does not look so bleak.