August 1, 2008
REITS POP, COMMODITIES FLOP
July 2008 was one of the more challenging months for strategic-minded investors in recent memory. There was plenty of red ink on last month's tally, as our table below shows, although the headwinds were even stronger than losses alone suggest.
Let's begin by noting that the big stumble last month came in commodities. The DJ-AIG Commodity Index, for instance, dropped by an astonishing 11.9% in July. That's the biggest month setback for the benchmark, as far as we can tell, based on records we can dig up going back to 1991. (Our ETF proxy in our table fared even worse, slipping more than 12% last month.)
Foreign stocks took it on the chin last month, too, although the pain was modest by comparison with commodities.
In the winner's column: REITs, which rebounded in July with a robust gain. Overall, we can say that REITs popped and commodities flopped.
The steep tumble in commodities was due mostly to oil's sharp drop last month. Since most commodities indices are heavily weighted in oil and energy, it's no surprise to learn that commodity benchmarks overall suffered in July. Unexpected? Hardly. Commodities generally have been rallying for years and the corrections along the way, at least on a monthly basis, have been relatively rare and quite mild for the most part. Taking some of the froth out of prices, particularly in oil, is long overdue and it wouldn't surprise us to see more of the same in the months ahead. Commodities generally are a volatile asset class, and if you factor that in with the record prices for many raw materials of late, it's no surprise to see downside volatility has finally come a-courtin'.
Expected or not, the reversal in commodity price fortunes last month weighs heavily on our Global Market Portfolio Index (GMPI), which suffered an unusually steep 4.5% loss in July. That's the biggest monthly setback for GMPI since we began calculating the index in January 2002. (GMPI is our unmanaged proprietary index of the global equity, bond, REIT and commodity markets, initially weighted by the respective market caps--or equivalent for commodities--as of December 31, 2001.)
At the end of 2001, GMPI was set with a 17% commodity weighting, based on the total dollar value traded for the components of the Goldman Sachs Commodity Index. Since then, an all-time commodity-weight high for GMPI was reached in June, at 28%. Last month, thanks to the sharp correction in commodity prices, the asset class's weight in GMPI dropped to about 26%. That's still fairly high, and so future corrections can't be ruled out.
But let's step back and consider the bigger picture. As the table above shows, GMPI for the past year is still down only marginally, by less than 1%. That's impressive if you consider that U.S. stocks are off by more than 10% for the same period. Yes, it's now clear that we should have all owned TIPS and foreign developed market bonds exclusively over the past 12 months. But such valuable information wasn't obvious 12 months ago, just as the big winners and losers for the next 12 months are largely unknowable in the here and now. As such, owning a bit of everything in some informed blend is the next best thing.
The lesson, once more, is that owning a proxy of the world's major exchange-listed asset classes serves investors well over time. That doesn't mean that GMPI is immune to bouts of volatility from time to time, as July reminds. But in the long run, we're confident that diversification will continue to serve strategic-minded investors well. Even after last month, the concept has held up impressively. All the more so if you consider that implementing the strategy costs less than 50 basis points (via ETFs) and requires no trading skills.
At the very least, GMPI or something equivalent is the ideal benchmark from which every strategic-minded investor can begin to analyze and construct a portfolio. Yes, there are reasons to consider changing this benchmark portfolio to suit your particular investment and risk requirements. But we should do so cautiously, and only when we're supremely confident that our adjustments have a decent chance of paying off. Indeed, beating the market--i.e., something that's close to a representative sampling of the true market portfolio--is still tough, and always will be. A monthly snapshot here or there may suggest otherwise, but for most of us our investment horizon isn't measured in single months and so we can't afford to get caught up in the trend du jour.
As a result, when we see performance outliers--both up and down--in monthly GMPI numbers, we should take it with a grain of salt. Ours is a long distance challenge, and monthly returns are a tiny--a very tiny--piece of generating financial success. Yes, we should routinely monitor the markets, and our portfolios, if only to understand what's happening. But let's be careful not to get frightened by volatility cycles, particularly when they're in full bloom, as they are now.
In fact, let's remain opportunistic when volatility comes to town. Extreme volatility breeds higher-than-average rebalancing opportunities if you're looking several years out.
The proverbial glass, in sum, isn't half empty--it's half full. Volatility is our friend in the long run, if only we can keep our emotions in check in the short run and take advantage of Mr. Market's deals as they emerge. Easy to say, tough to do. Nonetheless, that's still the best deal in town.
Posted by jp at August 1, 2008 10:16 AM
Here's a discussion about strategy as it relates to weighting and the global market portfolio:
Posted by: JP at August 4, 2008 12:15 PM
Great article! Thanx.
Could you provide me with a link to where you discussed weightings for the above assets?
Posted by: Anonymous at August 2, 2008 12:03 PM