Our Thoughts

Quarter in Review: First-Half Report Card: Mixed Gains

The recent turmoil in the investment markets (see Marjorie’s article here on the “roller coaster ride”) might cause one to think that people have lost money this year in U.S. stocks.  But in fact, most of the U.S. indices are sitting on double-digit gains, and the second quarter added to those gains.

Despite a rocky last month, the widely-quoted S&P 500 index of large company stocks gained 2.91% for the quarter and is up 13.82% since January 1.  Similarly, the Russell 2000 small-cap index was up 3.08% in the second three months of the year, posting a 15.86% gain in the year’s first half. 

The rest of the world is not doing as well.   The broad-based EAFE index of larger foreign companies in developed economies fell 2.11% in dollar terms during the second quarter of the year, and is up just 2.18% so far this year.  The EAFE Emerging Markets index of lesser-developed economies plunged 9.14% for the quarter, and is now down 10.89% for the year.

Looking over our alternative asset classes, real estate investments, as measured by the FTSE NAREIT index, fell 2.13% for the quarter, though it is still standing at a 5.79% gain for the year.  Commodities, as measured by the Dow Jones/UBS Commodities Index, fell 9.45% this past quarter, taking them down 10.47% for the year.

Bonds experienced a very difficult first half of the year, with much of the damage coming in late May and June.  The Barclay’s Global Aggregate bond index is down 4.83% so far this year, and the U.S. Aggregate index has lost 2.44% of its value in the same time period. 

Many investors have lost money in seemingly-safe Treasury bonds, but the damage was limited to bonds with longer maturities.  Higher yields, of course, means a decline in value for those holding the bonds; the decline in bond values has caused investors to sell a record $76.5 billion worth of bond funds during the month of June.

This is the kind of market environment that many investment advisors least enjoy – for a variety of reasons.  First, the turmoil over the past month makes it clear that investors are making investment decisions – and moving market prices – based on emotions rather than logic.  The initial panic following Fed Chairman Ben Bernanke’s comments about ending its QE3 stimulus program seems to have subsided.  But when market values drop precipitously based on a single speech about a hypothetical Fed action that would only be taken due to improved fundamentals, you know that investors are not thinking rationally. 

The other reason investment advisors dislike the current state of the markets is the way diversification looks right now. Whenever U.S. stocks are delivering positive returns while most everything else – international stocks, bonds, real estate, commodities, and all the other pieces of a prudently constructed portfolio – are going in the tank, investors will ask questions like: “The S&P 500 is up 14% so far this year, but my portfolio is only up 3%.  What are you doing wrong?”

The truth is, no professional can pick the one winning asset out of the myriad of options every year (or half year), and no prudent professional would ever try.  There will always be one asset that returns more than the others, and that winning asset will always be different.  Yet American investors hear about the S&P 500 (and the Dow, and other U.S. large stock indices) on the nightly news, so they are most likely to question the competence (or sanity) of their advisor when the U.S. stock markets are booming and everything else is lagging – exactly the situation we have today.  As most of our clients know, this is “frame of reference risk”…our client portfolios are very different than most peoples’ context for conversations or current events.

Eventually, some other investment will take the lead, diversified portfolios will look better relative to the U.S. stock indices, and investment advisors will look like geniuses.  That, too, will be a naive view of the situation, but it will be a more pleasant one for those of us who believe in the long-term value of diversification.