August 24, 2009
THE POWER & PERIL OF RECENT HISTORY
Expectations are driven by many things, but recent history usual tops the list when it comes to the crowd's outlook on things to come. No wonder, then, that investors are feeling pretty good about the prospects for equity markets, which have been soaring this year.
As our chart below illustrates in no uncertain terms, 2009 ranks as one of the best calendar years in terms of positive returns…so far. The "worst" performer, based on our slicing and dicing of the major regions/markets for the world's stocks, is Japan, dispensing a relatively slight 7.5% total return so far this year through August 21, according to data from Standard & Poor's. On the opposite extreme is the nosebleed ascent for Latin America, which is up an astounding 71% year to date.
It's been hard to lose money in equities this year. Virtually every corner of the global stock market is sitting on tidy gains. Along the way, claims of talent if not genius are once again being thrown about in the active management community, conveniently overlooking the fact that equity beta, which is available to everyone at virtually no cost, has delivered much of the heavy lifting this year.
But whether it's passive or active management that's provided this year's powerful gains, the bigger challenge is maintaining perspective about the future and how it will compare with the recent past. It wasn't that long ago that the crowd had abandoned equities in favor of near-zero yields in government bonds. Today, with extraordinary trailing returns staring us in the face, the temptation to extrapolate the recent past into the immediate future is once again calling.
The general lesson is that cycles prevail, in the economy and in the capital and commodity markets. These cycles are difficult to read, much less exploit in the short term. Yet strategic-minded investors can mine valuable intelligence in the ebb and flow of cycles for medium- and long-term horizons, a core principle that drives our analysis in The Beta Investment Report.
But we must be cautious. No lone market factor—be it dividend yield, volatility, correlation, etc.—can tell us much in isolation. Only by putting a range of variables into historical perspective can we begin to see the future with a bit more clarity, if only marginally.
Should we ignore recent price action? No, not entirely. Price momentum is a powerful force, especially in the short run, as recent history reminds once again. But that contrasts with the primary financial challenge that looms for most investors: funding long-term liabilities. Allowing recent history to dominate your worldview is tempting if not emotionally satisfying. Deciding if it's also strategically intelligent is something else altogether.
Posted by jp at August 24, 2009 10:28 AM
This year's big disappointment -- and danger -- is the continued high correlation of the major asset classes.
The soldiers are marching over the bridge in lockstep. You know what happens next.
Posted by: j'adoube at August 25, 2009 7:33 PM