August was another tough month for diversified portfolios. For the third month running, the Capital Spectator Global Market Portfolio Index lost ground in August, declining 3.3%.
For the major asset classes generally, last month was a mixed bag, as our table below shows. REITs were the leader, posting a 2.4% advance. U.S. stocks weren’t far behind, earning 1.7% for the month. The big loser in August: commodities, shedding 7.4%, a steep loss, which is all the more painful after July’s 12% decline. Foreign equities and bonds were also hard hit last month. Overall, August wasn’t pretty for broadly defined market-valuation-based portfolios.
Strategic-minded investors might wonder if owning a portfolio that’s diversified across the world’s major asset classes, and weighting the components by their respective market-valued share, remains an intelligent decision. Year-to-date, our Global Market Portfolio Index (GMPI) has shed 8.6%. That’s slightly better than U.S. stock performance, which posts a 10.1% loss through the end of August. Nonetheless, one might expect a broadly diversified multi-asset class portfolio to fare better. What’s going on?

In a word, correction. In fact, the reversal of GMPI’s fortunes this year comes as no shock to this editor. In fact, we’re surprised it didn’t come earlier. To see why, consider the longer term perspective. For the five years through last month, GMPI posted a 10% annualized total return vs. 7.6% for U.S. stocks (as per the Russell 3000). In addition, GMPI’s robust outperformance has come with roughly one-quarter less volatility compared with Russell 3000.
The fact that GMPI has delivered superior risk-adjusted performance relative to U.S. stocks was anticipated. But the fact that the outperformance has been so extreme in recent years was unexpected. As our graph below illustrates, owning the global market portfolio, passively allocated, has paid off handsomely. A little too handsomely, in our humble opinion. Beating the U.S. stock market by such a wide margin, although possible in the short run, can’t be sustained. Market equilibrium wins out eventually, which is why it’s tough to beat the major markets as a general rule.

Yes, GMPI is likely to deliver a small long-term performance premium, as well as a lower risk profile over time. But the edge is almost surely destined to be modest, as opposed to spectacular, as was the history in recent years until 2008. Thus the pullback in GMPI to more humble comparisons with U.S. stocks.
As such, we make the following predictions: First, GMPI is likely to fare relatively poor against stocks or bonds in the coming months, perhaps into 2009. Five years from now, on the other hand, we expect GMPI to handily beat either asset class on a risk-adjusted basis, and perhaps even on an absolute returns basis. In fact, we continue to forecast that GMPI will do well against most investment strategies over time. No guarantees, of course, but market history and common sense suggest no less. Alpha’s hard to sustain as a general proposition.
In short, the future looks more or less like the past when viewed through the prism of the global market portfolio–at least to your editor’s somewhat jaded eyes. As always, it’s easy to think otherwise by focusing on recent history. That was true when GMPI was blowing away the U.S. stock market from the vantage of a year ago; true by current standards. But for strategic-minded investors, the short run is still mostly noise.

3 thoughts on “NOISY BEHAVIOR

  1. vinnie

    Im a regular reader of your blog but I always hesitate to ask questions. Usually attempting to methodically take in all of the reporting/data in order to understand.
    2 things
    1)In ref to “noisy behavior”… What is the fundamental explanation for REIT’s out performance as an asset class? This industry is in complete flux. I dont understand 2)In ref to “labor pains” What is your fundamental response as an economist to those who refuse to accept that were in a recession based on the classical “2 quarters of negative growth” argument. I have my opinion but VERY curious what your blunt reply would be.

  2. JP

    First, thanks for reading. As to your questions, I can only speculate, and you know what that’s worth. But here’s a few observations for context.
    REIT yields are now relatively high and so that may encourage buying. Last month, equity REITs posted a 5.04% yield, according to NAREIT ( That compares favorably with a 10-year Treasury yield of just 3.84% at the end of August. Recall that REITs had a rough 2007. Was that because REIT yields fell below the 10-year Treausury yield at times in ’07? Perhaps, as we suggested in a post on Nov 13, 2007:
    But now that there’s a REIT yield premium once more, it makes the asset class look more attractive. Indeed, many REIT investors focus on yields as the main attraction of this sector.
    As to those who don’t think we’re in a recession, keep in mind that the general definition of 2 quarters of negative GDP growth has yet to arrive. In fact, by that standard, we may avoid a recession. Nonetheless, a contracting labor market suggests otherwise.
    A number of analysts say we may be entering a new era, when GDP rises or at least doesn’t fall even though the labor market shrinks. Perhaps the whole notion of defining a recession needs to be revised.

  3. MG

    “2 quarters of negative growth” for a recession is a myth, but its a lie that’s been repeated often enough by the MSM, people believe it.

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