Must Be Present to Win

3Q 2012

More than forty months into a bull market run, it turns out that most investors still aren’t grasping the magnitude of the global market recovery. For example, when a recent industry survey asked 1,000 investors whether they thought the S&P 500 was up or down during each of the past three years, 66% thought it was down in 2009, 48% thought it was down in 2010, and 53% thought it was down in 2011. In actuality, this frequently utilized benchmark for large domestic stocks gained 26.5% in 2009, 15.1% in 2010, and 2.1% last year.

Influenced at least partially by these ill-formed perceptions, fearful investment decisions at the macro level have been guiding dollars away from “risk assets” and toward the assumed certainty of cash or bonds. With this being the case, the common question of “Why is everyone underperforming the market?” becomes quite obvious. Market indexes of all varieties (domestic/foreign, large/small, etc.) remain consistently invested, operating without the tactical fear that can negatively impact outcomes during an unexpected rally.

The third quarter’s results could easily be classified as such, with globally strong performance propelling equity markets toward their pre-recession highs. As measured by the MSCI All-Country World Index, stocks as an asset class appreciated 6.8% during the last 90-days, are up 13.6% thus far in 2012, and have provided a return of 22.3% during the last 12-months. Notably, this has all occurred in the face of, among other things, a European debt crisis, the downgrading of the credit rating of the United States (the world’s reserve currency), fiscal debates in Congress, numerous natural disasters around the world, and an apparent slowing of global economic activity.

As we can now dissect recent results and apply the benefit of hindsight, the concept of “must be present to win” makes itself very evident. Keep in mind that the bulk of this upward movement has come on only a handful of days, which generally coincided with major central bank meetings or remarks. In late July, the European Central Bank (ECB) announced that it would do “whatever it takes” to maintain the monetary union and agreed to purchase troubled countries’ debt virtually without limits. In similar fashion, the U.S. Federal Reserve voted in September to embrace a third round of quantitative easing (QE3) in order to address weak GDP growth and persistently high unemployment. Strip those days out of the equation and the markets would have been virtually unchanged as both measured volatility and trading volumes otherwise vacationed during the summer months. Admitting no insights as to when the headwinds will be overcome (temporarily or more lasting), we offer the lesson of disciplined engagement throughout all periods.

Of course, there are logical and appropriate reasons for investors to trail the market’s headline performance. Specifically, we abide by portfolio design concepts that include a dose of non-equity elements to diversify and adjust overall volatility in a way that’s aligned with each client’s risk tolerance. Although low yields on bonds can be frustrating, and the 5.2% trailing 12-month performance of the Barclay’s Aggregate Bond Index may seem difficult to replicate going forward, greatly increasing the risk profile of your portfolio in search of higher income can be detrimental. Likewise, the alternative investments that represent a growing portion of most client portfolios are not in place for their recent performance, but rather their historic ability to enhance diversification and provide downside hedging.

We acknowledge the risks that remain around the world, and specifically here in the U.S. given the political uncertainty of the November elections and the potential impact on fiscal and tax policy. That said, successful investing demands a choice between prudent risk control and outright risk avoidance. Attempting to escape all the risks is capitulation, a course that leaves much of the future rewards for others. Our intent as your advisor is to shepherd you through the circumstances of the day to deliver upon the long-term goals set forth.