State of Grace

4Q 2012

To journey through the fourth quarter of 2012 without knowing the score, one might have reasonably thought that markets were losing ground. After all, the polarizing emotion of our national elections followed by Washington’s clumsy grappling with the “fiscal cliff” surely couldn’t have gone unnoticed. Well, that’s what we all get for thinking; or at least for choosing to fixate on the vulnerable forecasts of market pundits or the catchy headlines and graphics that commentators from Fox News, CNBC, or MSNBC utilize to constantly saturate our senses.

In reality, global markets have recently displayed an impressive level of grace, capable of overcoming not only the worldly challenges of our day but the fear that naturally comes with uncertainty. As measured by the MSCI All-Country World Index (ACWI), stocks as an asset class appreciated 3.0% during the last 90-days of 2012. Quarterly performance was carried largely by companies domiciled outside of the United States as those valuations remained relatively attractive. For the entire year, a better-than-average return of 16.8% translates into roughly $6.5 trillion of increased wealth for participating investors. Clients of BAMG should hopefully recognize themselves as part of this total, and we’re optimistic that it will spark a renewed level of confidence. If not, please consider that over the last 10- years, despite some painful memories of all that’s transpired, this most broad-based benchmark for equities has provided an annualized total return of 8.7% per year. While barely beyond the shadows of the “lost decade”, it’s noteworthy to mention how this longerterm figure is starting to rhyme pretty well with the historic market averages.

Looking now at the non-equity elements, it can be observed that the final quarter of 2012 was icing on the cake of an exceptional year for diversified bond portfolios. Although interest rates rose modestly toward the end of the period, the yield on the 10-year U.S. Treasury bond remained below the measured rate of inflation. This drove income-focused investors into more credit sensitive corners of the fixed income universe, including mortgage or asset-backed securities, investment grade corporates & high yield, and emerging market debt. Acknowledging the unlikely repeat of recently strong returns in 2013, we remain confident that a managed, multi-strategy bond approach will continue to deliver acceptable risk-adjusted returns going forward.

Alternative investments, which represent a growing portion of most client portfolios, have produced varied results in recent periods. Global real estate has been a shining star, and was the performance leader among all asset classes last year. The multi-alternative strategies we’re now utilizing delivered positive, albeit more muted returns. Still, the primary benefit of these holdings remains their anticipated ability to enhance portfolio level diversification and provide downside hedging. We’ve seen evidence of this working during the brief periods of market stress within the last few quarters.

With prevailing grace, one of the biggest surprises of 2012 was a dramatic decline in the market’s implied volatility for stocks, bonds, and even currencies. While an extension of this condition is largely out of our control, we’ll offer the following positive considerations to hopefully support your faith and help keep you productively engaged:

• Global monetary policy remains very accommodative, focused on driving investors out of cash & bonds. This has not happened yet.
• Despite the fiscal drag of a shrinking deficit, the U.S. economy continues to grow at a modest pace and jobs are being added.
• Corporate and personal balance sheets are in good shape relative to the public sector. Along with improving consumer confidence, the private sector may soon re-establish its role of economic leadership.
• Valuations, specifically for global stocks, remain below their historic averages. Opportunity rarely occurs in times of “certainty”.

The antidote for fear is not safety; it’s learning how to face the encountered fear. With a sincere respect for the unknown, those of us at BAMG attempt to serve as trusted risk managers. Regardless of the environment, there will be plenty of good that can be done in 2013.