Actually, it never left, even if it seemed otherwise. Perhaps it was hibernating for a few years. No longer. As November’s tally of mixed performance among the major asset classes shows, the prospect of throwing money at virtually anything and earning a tidy return suddenly looks conspicuous by its absence as a prospective opportunity.
The numbers, as always, tell the story. As our chart below documents, selection was everything in last month’s financial horse race. Indeed, TIPS were the best performer, rising more than 4% in November. In last place: REITs, which shed a hefty 9.5%. Looking at the year-to-date returns for two shows an almost mirror image of results: TIPS are up 11.9% in 2007 through November 30; REITs have lost 11.7% YTD.
Red ink, in fact, is a growing presence on our table above. That’s just another way of saying that volatility has returned. Anything’s possible, of course, but it’s starting to look like nuance and variability has returned to the money game. As a result, the details matter once more in building and managing diversified portfolios. The game once again favors the nimble asset allocators, or so we predict.
With less than a month to go, it looks like 2007 may be the first calendar year since 2005 when a major asset class suffered a loss. Two years ago, foreign government bonds (as per Citi Non-$ World Gov’t Bond Index) tumbled more than 9% in dollar terms, although returns measured in local currencies left the benchmark with a gain of 3.9% that year. Barring gray area, the last time unambiguous pain hit was 2002, when foreign and domestic equities crumbled. If we use 2002 as the standard, it’s been a long and virtually uninterrupted stretch of gains across the board.
But as we’ve been writing this year, the good times for all the asset classes were living on borrowed time. Expecting otherwise at this late date in the financial cycle was asking for a miracle.
No surprise, then, that a reversal of fortunes appears to have arrived in earnest. Actually, that’s good news for strategic-minded investors, who recognize that lower prices translate into higher expected returns. Capturing the rebalancing bonus requires buying asset classes that have fallen on hard times and lightening up on those that have been soaring. Of course, it may be too early to mindlessly chase red ink, but if the selling continues in REITs, for instance, we’d be inclined to start nibbling.
Keep in mind, however, that the long bull market in REITs (which started in 2000, by our calculation) may take time to unwind. Patience, in other words, may be required. Meantime, consider that the yield for equity REITs (as per NAREIT) was 4.6% at last month’s close. The good news: that’s now comfortably above the 10-year Treasury’s 3.98% yield on November 30. Does a 60-basis-point risk premium for REITs suffice? For our money, it’s a bit thin, especially if you consider that REITs may be facing more selling after years of non-stop gains. Real estate generally, in case you haven’t noticed, is a bit stressed these days. As such, we’re waiting but watching.
As for the other big loser last month–emerging markets stocks–we’re inclined to wait even longer before even thinking about a large, new commitment. Yes, we keep reading about how emerging markets have matured and are no longer dependent on the U.S. economy for a bullish tailwind. But that’s still just a theory and it has yet to be tested under fire. Adding to our cautious outlook is the fact that emerging markets equities are still flying high YTD. Unless you have zero exposure to emerging markets, we’d advise waiting here as well.
Then again, we could be wrong, and it wouldn’t be the first time. Recognizing our limitations as mere mortals, we trust only in broad diversification across the major asset classes, tweaking the mix every now and again. If and when an extreme move arrives, we’ll be looking to take a more aggressive rebalancing posture.
Speaking of which, in considering 2008, we’re expecting to redeploy some of our overweight cash allocation. Exactly where and when we’ll redeploy remains an open question; we’re waiting for additional clues from Mr. Market. But the winds of opportunity are starting to blow. Yes, it’ll take a contrarian mindset to capitalize on the volatility. Then again, no one ever said success in investing would be comfortable and stress free.