Seeing the market in a different light

November 3, 2011 Categories: Economic Insights
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If the current market volatility is bringing back too many negative memories of the fall of 2008, a different frame of reference may help…

Daily Balanced Index Portfolio

Balanced index portfolio represented by:40% Russell 3000® Index, 20% Russell Global ex-U.S. Index, and 40% Barclays Capital Aggregate Bond Index. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. The CBOE VIX (Chicago Board Options Exchange Volatility Index) measures annualized implied volatility as conveyed by S&P 500 stock index option prices.

Mark Eibel, our director of client investment strategies,  sees the market’s year-to-date performance in a different light.  Here’s his take:

Imagine that we sat down last New Year’s Eve, and I had laid out the following scenario:

  • The municipal bond market will still roil from the doomsday scenario painted in late 20101
  • 3 months into the year, one of the largest economies of the world will shut down because of an earthquake, a tsunami and a nuclear reactor disaster2
  • Middle East conflicts in the spring will result in oil supply shocks, price spikes and further instability in the region3
  • Europe will continue to be even more uncertain than it was in 20104
  • In the summer, the U.S. will get within 24 hours of defaulting and settle for a downgrade of its debt by Standard & Poor’s5
  • The U.S. will continue to have anemic economic growth, high unemployment, and housing will remain a problem6
  • Over the summer, market volatility as measured by the VIX, will increase to levels not seen since the fall of 20087

This is a pretty dark crystal ball, for sure.  But if you could humor this doomsayer for a moment,  what do you think clients’ portfolios would look like as a result of all this?

You might think those individual disasters would add up to financial Armageddon.  But we know for now, at least, that would be wrong. Certainly, the year has been a struggle for equities, but a diversified portfolio has done what it’s designed to do. And that’s manage risk.

If your client started with $100,000 on New Year’s Eve 2010 invested hypothetically with 40% in the Russell 3000® Index, 20% in the Russell Global ex-U.S. Index, and 40% in the Barclays Capital Aggregate Bond Index, at the end of the day of this writing (October 21, 2011), the value was $99,595.

Against this backdrop, investors can appreciate that diversified portfolios have held up better than they might have expected.  This balanced index portfolio (40% Russell 3000® Index, 20% Russell Global ex-U.S. Index, and 40% Barclays Capital Aggregate Bond Index) lost -0.4% while the broad U.S. market (Russell 3000® Index) lost -1.1% and broad global market (Russell Global ex-U.S. Index) lost 12.0% year to date through October 21, 2011.  The combination of U.S. Equity and International Equity and Fixed Income, help to soften the effects of extreme movements from any one asset class.

‘But if only I’d had more fixed income I would have done better,’ your clients might lament.  Let’s remember at the start of the year many wanted out of fixed income as interest rates were low and municipal bond doomsday stories were getting a lot of play in the media.

It is a similar story with international equities right now: clients want less exposure when U.S. equity markets are ‘beating’ non-U.S. markets.  But it’s easy to forget those periods during 2002-2007 when international markets were ‘beating’ U.S. markets and they were clamoring for more international exposure.

Here’s the bottom line: most people don’t have crystal balls to predict the future. For those of us who can’t, a diversified portfolio can provide a sensible way forward.

1 Warren Buffett hints at bond bubble, by Colin Barr, CNN Money, October 5, 20102  Poster of the Great Tōhoku earthquake, USGS March 11, 20113 The Arab world: Crescent moon, waning west, The Economist, October 29, 2011

4 U.S. says Europe crisis creates global uncertainty, Reuters U.S. edition, October 25, 2011

5 S & P downgrades U.S. credit rating for the first time, by Zachary Goldfarb, The Washington Post, August 8, 2011

6 U.S. Economy: Confidence Decreases, home prices stagnate, by Bob Willis and Shobhana Chandra, Businessweek, October 25, 2011

7 VIX CBOE Volatility Index, Investopedia

The Russell Global ex-U.S. Index measures the performance of the global equity market based on all investable equity securities, excluding companies assigned to the United States.The Russell Global ex-U.S. Index is constructed to provide a comprehensive and unbiased barometer for the global segment and is completely reconstituted annually to accurately reflect the changes in the market over time.

The Russell 3000® Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.The Russell 3000® Index is constructed to provide a comprehensive, unbiased, and stable barometer of the broad market and is completely reconstituted annually to ensure new and growing equities are reflected.

The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market.The Russell 1000®Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are reflected.

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