Prediction Season

December 2016santa rally
The close of each calendar year brings with it the holidays as well as a chance to look forward to the year ahead. In the coming weeks, investors are likely to be bombarded with predictions about what the future, and specifically the next year, may hold for their portfolios. These outlooks are typically accompanied by recommended investment strategies and actions that are aimed at trying to avoid the next crisis or missing out on the next “great” opportunity. When faced with recommendations of this sort, it would be wise to remember that investors are better served by sticking with a long-term plan rather than changing course in reaction to predictions and short-term calls.

PREDICTIONS AND PORTFOLIOS
One doesn’t typically see a forecast that says: “Capital markets are expected to continue to function normally,” or “It’s unclear how unknown future events will impact prices.” Predictions about future price movements come in all shapes and sizes, but most of them tempt the investor into playing a game of outguessing the market. Examples of predictions like this might include: “We don’t like energy stocks in 2017,” or “We expect the interest rate environment to remain challenging in the coming year.” Bold predictions may pique interest, but their usefulness in application to an investment plan is less clear. Steve Forbes, the publisher of Forbes Magazine, once remarked, “You make more money selling advice than following it. It’s one of the things we count on in the magazine business—along with the short memory of our readers.” Definitive recommendations attempting to identify value not currently reflected in market prices may provide investors with a sense of confidence about the future, but how accurate do these predictions have to be in order to be useful?

Consider a simple example where an investor hears a prediction that equities are currently priced “too high,” and now is a better time to hold cash. If we say that the prediction has a 50% chance of being accurate (equities underperform cash over some period of time), does that mean the investor has a 50% chance of being better off? What is crucial to remember is that any market-timing decision is actually two decisions. If the investor decides to change their allocation, selling equities in this case, they have decided to get out of the market, but they also must determine when to get back in. If we assign a 50% probability of the investor getting each decision right, that would give them a one-in-four chance of being better off overall. We can increase the chances of the investor being right to 70% for each decision, and the odds of them being better off are still shy of 50%. Still no better than a coin flip. You can apply this same logic to decisions within asset classes, such as whether to currently be invested in stocks only in your home market vs. those abroad. The lesson here is that the only guarantee for investors making market-timing decisions is that they will incur additional transactions costs due to frequent buying and selling.

The track record of professional money managers attempting to profit from mispricing also suggests that making frequent investment changes based on market calls may be more harmful than helpful. Exhibit 1, which shows S&P’s SPIVA Scorecard from midyear 2016, highlights how managers have fared against a comparative S&P benchmark. The results illustrate that the majority of managers have underperformed over both short and longer horizons.


 

Exhibit 1. Percentage of US Equity Funds That Underperformed a Benchmark
pred 1

Source: SPIVA US Scorecard, “Percentage of US Equity Funds Outperformed by Benchmarks.” Data as of June 30, 2016. The S&P data is provided by Standard & Poor’s Index Services Group.

Rather than relying on forecasts that attempt to outguess market prices, investors can instead rely on the power of the market as an effective information processing machine to help structure their investment portfolios. Financial markets involve the interaction of millions of willing buyers and sellers. The prices they set provide positive expected returns every day. While realized returns may end up being different than expected returns, any such difference is unknown and unpredictable in advance.

Over a long-term horizon, the case for trusting in markets and for discipline in being able to stay invested is clear. Exhibit 2 shows the growth of a US dollar invested in the equity markets from 1970 through 2015 and highlights a sample of several bearish headlines over the same period. Had one reacted negatively to these headlines, they would have potentially missed out on substantial growth over the coming decades.

Exhibit 2. Markets Have Rewarded Discipline
Growth of a dollar—MSCI World Index (net dividends), 1970–2015

pred 2

In US dollars. MSCI data © MSCI 2016, all rights reserved.

CONCLUSION
As the end of the year approaches, it is natural to reflect on what has gone well this year and what one may want to improve upon next year. Within the context of an investment plan, it is important to remember that investors are likely better served by trusting the plan they have put in place and focusing on what they can control, such as diversifying broadly, minimizing taxes, and reducing costs and turnover. Those who make changes to a long-term investment strategy based on short-term noise and predictions may be disappointed by the outcome. In the end, the only certain prediction about markets is that the future will remain full of uncertainty. History has shown us, however, that through this uncertainty, markets have rewarded long-term investors who are able to stay the course.

 

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

History on the Run

running money

When news breaks and markets move, content-starved media often invite talking heads to muse on the repercussions. Knowing the difference between this speculative opinion and actual facts can help investors stay disciplined during purported “crises.”

At the end of June this year, UK citizens voted in a referendum for the nation to withdraw from the European Union. The result, which defied the expectations of many, led to market volatility as participants weighed possible consequences.

Journalists responded by using the results to craft dramatic headlines and stories. The Washington Post said the vote had “escalated the risk of global recession, plunged financial markets into free fall, and tested the strength of safeguards since the last downturn seven years ago.”1

The Financial Times said “Brexit” had the makings of a global crisis. “[This] represents a wider threat to the global economy and the broader international political system,” the paper said. “The consequences will be felt across the world.”2

It is true there have been political repercussions from the Brexit vote. Theresa May replaced David Cameron as Britain’s prime minister and overhauled the cabinet. There are debates in Europe about how the withdrawal will be managed and the possible consequences for other EU members.

But within a few weeks of the UK vote, Britain’s top share index, the FTSE 100, hit 11-month highs. By mid-July, the US S&P 500 and Dow Jones Industrial Average had risen to record highs. Shares in Europe and Asia also strengthened after dipping initially following the vote.

Yes, the Brexit vote did lead to initial volatility in markets, but this has not been exceptional or out of the ordinary. One widely viewed barometer is the Chicago Board Options Exchange Volatility Index (VIX). Using S&P 500 stock index options, this index measures market expectations of near-term volatility.

graph vix

You can see by the chart above that while there was a slight rise in volatility around the Brexit result, it was insignificant relative to other major events of recent years, including the collapse of Lehman Brothers, the eurozone crisis of 2011, and the severe volatility in the Chinese domestic equity market in 2015.

None of this is intended to downplay the political and economic difficulties of Britain leaving the European Union, but it does illustrate the dangers of trying to second-guess markets and base an investment strategy on speculation.

Now the focus of speculation has turned to how markets might respond to the US presidential election. CNBC recently reported that surveys from Wall Street investment firms showed “growing concern” over how the race might play out.3

Given the examples above, would you be willing to make investment decisions based on this sort of speculation, particularly when it comes from the same people who pronounced on Brexit? And remember, not only must you correctly forecast the outcome of the vote, you have to correctly guess how the market will react.

What we do know is that markets incorporate news instantaneously and that your best protection against volatility is to diversify both across and within asset classes, while remaining focused on your long-term investment goals.

The danger of investing based on recent events is that the situation can change by the time you act. A “crisis” can morph into something far less dramatic, and you end up responding to news that is already in the price.

Journalism is often described as writing history on the run. Don’t get caught investing the same way.

1. “Brexit Raises Risk of Global Recession as Financial Markets Plunge,” Washington Post, June 24, 2016.
2. “Brexit and the Making of a Global Crisis,” Financial Times, June 25, 2016.
3. “Investors are Finally Getting Nervous about the Election,” CNBC, July 13, 2016.

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee. When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

 

 

Recent Market Volatility

 WE SHOULD EXPECT VOLATILITY

JANUARY 2016

Do returns during January provide information about returns during the remainder of the year?Boat

As we would expect over any period, prices in January 2016 changed from day-to-day as aggregate expectations changed and investors processed new information. During the month, the S&P 500 Index had a return of −4.96%, the ninth lowest return for the index since 1926. The first two weeks of January was the worst start to the year for the S&P 500 in history, with the index returning −7.93% from January 4–15.

The market events of January 2016 provide an opportunity to examine several questions important to investors and revisit some fundamental principles of investing in capital markets.

Based on this information, some investors may wonder whether the returns in January have some predictive power for the returns during the remainder of the year. Exhibit 1 shows the returns of the S&P 500 Index for the month of January compared with the subsequent 11-month return (i.e., February through December). We find that a negative January was followed by a subsequent 11-month return that was positive 59% of the time, with an average return of 7%, indicating a negative January does not predict poor market returns for the rest of the year.

Recent Volatility chart 1

Recent Volatility chart 2

volatility chart 3One additional not: if we look at the five lowest January returns, excluding January 2016, the average return for the remainder of the year was 13.8% and none of these years finished in the lowest 20 years of annual returns for the S&P 500 Index.

PREVIOUS MARKET DECLINES
What have we seen during previous market declines?

As mentioned above, the YTD return for the S&P 500 through January 2016 was −4.96%. From the previous high on November 3, 2015 through its low on January 15, 2016, the S&P was down −10.43%, its second decline of at least 10% since the beginning of August 2015. We can look at the data in Exhibit 2 to see how the US market has performed in subsequent periods following different magnitudes of decline. The exhibit looks at previous times when the S&P Index has declined by 10% and 20%, and shows the subsequent one-, three-, and five-year return. Independent of the magnitude of decline, on average, the return of the S&P 500 over the periods referenced has been positive and greater than the long-term average of 10.02% in half of the time periods observed. The chart also provides information on developed ex US and emerging markets, where we have seen similar results.

VOLATILITY
Is the recent period abnormally volatile?

For the period January 1926 to the December 2015, the S&P 500 had a compound return of 10.02% and a standard deviation of 18.85. Looking over a more recent period, from January 2010 through December 2015, the return for the S&P 500 has been 12.98% with a standard deviation of 13.09. Comparing these results with other historical periods, we can see the recent period has not necessarily been more volatile. During the so-called “Lost Decade” from January 2000 to December 2009, the S&P 500 Index had a compound return of −0.95% and an annualized standard deviation of 16.13. When we continue to look at the data in Exhibit 3, grouped by decade starting in January 1930, we see periods of higher and lower returns as well as periods of greater and lesser volatility.

 

IMPORTANCE OF DISCIPLINE

While in the midst of a market downturn, we may be inclined to look for some type of signal as to what the recent period means for future returns or to assume the current period is somehow different from what we have observed historically. Before jumping to conclusions or attempting to make predictions about what the future may hold, analyzing the available data can provide perspective. It is also important to remember that there is ample evidence that suggests prices adjust in such a way that every day there is a positive expected return on our invested capital. While the realized return over any period may be positive or negative, in expectation we believe markets will go up. As investors, we should remain disciplined through all periods in order to capture the expected returns the market offers.

 

All Charts by Dimensional Funds

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

2015 Review: Economy & Markets

rollercosterThe US economy and broad market showed modest gains during the year, although investor discipline was tested by news of a global economic slowdown, rising market volatility in China and emerging markets, falling oil and commodities prices, and higher US interest rates.

The S&P 500 Index logged a 1.38% total return. The returns across US indices were mixed, but overall the broad US market, as measured by the Russell 3000, gained 0.48%—its lowest return since the 2008 market downturn. The Nasdaq Composite Index returned 6.96%. Performance among non-US markets was mostly negative: The MSCI World ex USA Index logged a ‒3.04% total return and the MSCI Emerging Markets Index a ‒14.92% return (net dividends, in USD). The US dollar’s strong performance against major currencies resulted in lower returns for US investors in various markets. For example, the MSCI All Country World Index returned 1.27% in local currency but ‒2.36% in USD (net dividends).

For most of the year, investors considered the potential impact of higher US interest rates triggered by a US Federal Reserve Bank (Fed) rate increase. The Fed’s announcement finally came in December and by year-end, the yield on the benchmark 10-year Treasury note stood at 2.27%, up from 2.17% in 2014. The Barclays US Government Bond Index returned 0.86% and Barclays US Intermediate Corporate Index returned 1.08%. Global government bonds had slightly positive returns with the Citigroup World Government Bond 1–5 Year Index (USD hedged) returning 1.00%. Global corporate bonds also had positive returns, with the Barclays Global Aggregate Corporate Bond Index 1–5 Years (hedged to USD) returning 1.21%.

2015 1st pic

The chart above highlights some of the year’s prominent headlines in context of broad US market performance, measured by the Russell 3000 Index. These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.

The chart below offers a snapshot of non-US stock market performance (developed and emerging markets), measured by the MSCI All Country World ex USA Index. The headlines should not be viewed as determinants of the market’s direction but as examples of events that may have tested investor discipline during the year.

2015 2ond pic

Global Backdrop

US Economy

The US economy grew modestly during 2015. Gross domestic product (GDP) increased only 0.6% in Q1 before improving to 3.9% in Q2 (year over year). Growth slowed to 2.0% in Q3, matching the average annualized growth for the past six years. Q4 GDP growth was forecasted to decline to 1.0% and GDP growth for all of 2015 to average 2.5%.

Positive economic signs in 2015 included lower unemployment, which fell from 5.7% in January to 5.0% in the last three months of the year—the lowest rate since 2008. Overall, the economy added 2.7 million jobs, capping the second-best annual gain since 1999. December wages were up 2.5% (year over year), which marked one of the best gains of the current expansion, although still below the 6.33% annual average. Inflation (personal consumption expenditures index) remained low. November’s 0.5% rate (year over year) marked the 43rd straight month of annualized inflation below the Fed’s 2% target rate. US housing activity remained solid with price growth, as measured by the S&P/Case-Shiller Home Price Index, rising 5.2% (year over year) through October. New home sales increased 14.5% through November. Consumer confidence also improved, with the University of Michigan’s Index of Consumer Sentiment averaging 92.9 in 2015—the highest since 2004. Consumer spending, which accounts for more than two-thirds of US economic activity, grew 3.0% in Q3.

Negative economic indicators included declining US factory activity. In December, the Institute for Supply Management’s (ISM) index fell to 48.2 from 48.6 in November, which was the weakest reading since the final month of the recession in June 2009. (Readings below 50 indicate contraction.) Corporate profits declined in Q1 and Q3 by 5.8% and 1.6%, respectively, and profits at S&P 500 companies were projected to fall by 3.6% in Q4.

Global Economy 2015 3rd pic colum

In 2015, economic growth was the weakest since the financial crisis. In December, the Organization for Economic Cooperation and Development (OECD) revised its 2015 world growth estimate downward to 2.9%—well below the historical average of 3.6% per year.

Eurozone GDP growth increased 0.5% in Q1, which was the strongest quarterly rate since its regional recovery began in early 2013. But the pace slowed to 0.4% in Q2 and to 0.3% in Q3. The slowdown came in spite of improved consumer spending sparked by lower energy prices and the European Central Bank’s (ECB) quantitative easing efforts. A decline in the euro’s value boosted exports and contributed to an improved current account surplus (3.7% of GDP) in 2015. Japan’s economy showed signs of improvement early in 2015 by posting a 3.9% GDP growth rate in Q1. Growth in Q2 reversed with a –0.7% rate before rebounding to 1% in Q3.

China, the world’s second largest economy, showed signs of a slowdown during 2015, with Q1 and Q2 growth reported at 7% and Q3 growth falling to 6.9%, which was less than half the growth rate in 2010. The Chinese government later revised its growth target to 6.5%, reflecting the weakest growth in 25 years.

After several years of robust growth, emerging market nations began to feel the effects of China’s slowdown, persistently weak global commodity prices, and the prospect of higher US interest rates. In Q4, the International Monetary Fund (IMF) cut its 2015 growth estimate for emerging markets to 4%, which marked the fifth consecutive year of declining growth.

Oil Market Decline

The world oil market continued its dramatic slide. After falling more than 50% in 2014, oil declined another 30% to end 2015 at $37.04 a barrel for West Texas intermediate crude, marking the largest two-year price drop on record. Factors affecting the price decline include: (1) excess supply spurred in part by higher production in North America, Middle East, and Russia, (2) slack demand due to slowing global growth, especially in the emerging markets, and (3) OPEC’s waning ability to influence market prices by adjusting its production. While cheap oil was a boon to consumers in developed economies, the steep price decline brought uncertainty to financial markets and industry sectors as firms curtailed spending and canceled projects, and oil-exporting countries collected lower tax revenues and struggled with the effects of a weaker currency.

Diverging Paths for Central Banks 

The divergence in actions by the major central banks in 2015 marked the first time since the euro’s launch that the Fed, ECB, and Bank of England have been compelled to strike different monetary paths as a result of diverging economies. In the late 1990s, the booming global economy led the central banks to apply rate hikes, while the 2001–2003 market decline brought similarly timed rate cuts.

In September, the Fed postponed raising interest rates, citing concerns with the economy, inflation, and worldwide market volatility. The central bank raised its benchmark rate by a quarter point in December—its first rate hike since 2006—and stated that it would continue on a gradual course of monetary tightening as long as inflation and economic growth allowed. The impact on the US financial markets was negligible, as rates had already begun to increase in anticipation of the move. Even as the US central bank began monetary tightening, most banking authorities across the globe were taking measures to ease their country’s monetary policy in response to signs of an economic slowdown. The ECB implemented a major stimulus program throughout the year, and in December announced new quantitative easing measures along with Japan. More than 40 central banks across the globe eased monetary policy in 2015.

China’s Rising Influence

Markets closely followed the news about China’s declining economic growth and the severe downturn over the summer, when the Chinese equity market declined more than 40% from its peak. Attempts by the Chinese authorities to support stock prices and the Bank of China’s surprise devaluation of the yuan raised questions about China’s impact on the economies of trading partners. The events also pointed to the stresses the government faces in implementing additional free-market reforms and transitioning its economic model from heavy industry and exports to one based more on consumer spending.

Market Summary2015 Investment Overview

In the US equity markets, most major indices logged negative performance, despite a strong rebound during Q4. For the year, the S&P 500 Index returned 1.38%; the Russell 3000 Index 0.48%; and the Russell 2000 Index ‒4.41%.

US market volatility, measured by the Chicago Board Options Exchange Market Volatility Index (VIX), declined steadily for the first half of 2015, but jumped to its highest level in six years in late August, following the US market decline. During Q4, the index dropped then rose again to close slightly higher for the year.

2015 4th pic columNon-US developed stock markets experienced mixed performance across almost all major indices (returns in USD, net dividends). The MSCI World ex USA Index, a benchmark for large cap stocks in developed markets outside the US, returned ‒3.04%. Small cap and value stock returns were mixed: The MSCI World ex USA Small Cap Index returned 5.46% and MSCI World ex USA Value Index returned ‒7.68%. The MSCI World ex USA Growth Index was positive at 1.65%. Emerging markets were among the worst global performers: The MSCI Emerging Markets Index returned -14.92%; the small cap subindex returned ‒6.85%; the value subindex returned ‒18.57%.

Among the equity markets tracked by MSCI, nearly half of the countries in the non-US developed markets index had negative total returns (in USD) and the range of returns was broad. The top three return countries were Denmark (23.43%), Ireland (16.49%), and Belgium (12.10%). Countries with the lowest returns were Canada (‒24.16%), Singapore (‒17.71%), and Spain (‒15.64%).

In emerging markets, 21 of 23 countries tracked by MSCI logged negative total returns (in USD) and the dispersion of returns was broader than in the developed countries. Hungary (36.31%), Russia (4.21%), and India (‒6.12%) were the top-performing countries in the index. The lowest returns in the index came from Greece (‒61.33%), Colombia (‒41.80%), and Brazil (‒41.37%).

Returns of major fixed income indices were slightly positive. One-year US Treasury notes returned 0.15%, Barclays US Government US Bond Index 0.86%, Citigroup World Government Bond Index (1‒5 years, USD hedged) 1.00%, and Barclays US TIPS index returned ‒1.44%. The Barclays Global Aggregate Corporate Bond Index 1–5 Years (hedged to USD) returned 1.21%.

US and global real estate securities had mixed performance: The Dow Jones US Select REIT Index returned 4.48%, and the S&P Global ex US REIT Index returned ‒3.54%. Commodities were negative for the fifth year in a row, with the Bloomberg Commodity Total Return Index returning ‒24.66%. Among the composite indices, petroleum returned ‒39.42% and industrial metals ‒26.88%. Among the single commodity indices, Brent crude (‒45.57%) and West Texas intermediate crude (‒44.35%) were the worst performers. Natural gas returned -39.95%. Gold was down for the third year in a row at ‒10.88%; silver prices returned ‒12.72%. Cotton was the only commodity in the index to post a positive return (2.97%).

The US dollar rose against most major currencies, including the euro, pound, and yen. The dollar’s strength had a negative impact on returns for US investors with holdings in unhedged non-US assets. For example, in 2015, the dollar’s rise relative to the euro hurt the returns of US investors in European markets. The MSCI Europe Index (net dividends) returned 8.22% in euro but ‒2.84% in US dollars. This was the case in other regions where the dollar outperformed local currencies. Examples: The MSCI United Kingdom Index (net dividends) returned ‒2.21% in pounds and ‒7.56% in USD. The MSCI Australia Index returned 1.29% in Australian dollars but ‒9.95% in USD.

Currency Impact

Performance of Size and Value Premiums

Based on the respective total returns of the Russell indices1within the size dimension, US small cap stocks underperformed US large cap stocks by ‒5.33% (‒4.41% vs. 0.92%). Within the relative price dimension, US value underperformed US growth by ‒9.22% (‒4.13% vs. 5.09%). Among US small cap stocks, small value underperformed small growth by ‒6.09% (‒7.47% vs. ‒1.38%); among US large cap stocks, large value underperformed large growth by ‒9.49% (‒3.83% vs. 5.67%).

As in most years, diverging performance of various subindices in 2015 underscores the fact that the premium within a particular dimension (e.g., size or value) does not always move in the same direction across the global markets. For example, although the size premium was negative in the US, it was positive in both the developed non-US and emerging markets for the year. The MSCI World ex USA Small Cap Index outperformed the MSCI World ex USA Index by 8.50% (all returns in USD, net dividends). The MSCI Emerging Markets Small Cap Index outperformed the MSCI Emerging Markets Index by 8.07%. Value premiums outside the US were generally negative. The MSCI World ex USA Value Index underperformed its growth counterpart by ‒9.33%; the MSCI Emerging Markets Value Index underperformed the MSCI Emerging Markets Growth Index by -7.24%.

Annual underperformance of the size and value premiums is not unusual from a historical standpoint. Although small cap and value stocks have offered higher expected long-term returns relative to their large cap and growth counterparts, these return premiums do not appear each year.1 For example, since 1979, US small caps have outperformed large caps in 19 of the 37 calendar years—or 51% of the time. Results are similar for the relative price dimension. Since 1979, US value has outperformed growth in 20 of 37 calendar years—or 54% of the time. Small cap value has outperformed small cap growth in 57% of the calendar years.

History also has produced multiyear periods in which US small cap and value stocks did not outperform large caps and growth. The most recent example is three-year underperformance of small cap value vs. small cap growth (2013‒2015). Small value has also underperformed in three straight years (2009‒2011 and 1989‒1991). Other multiyear examples include small caps underperforming large caps (1984‒1987 and 1994‒1998) and value underperforming growth (1989‒1991 and 2009‒2011). Yet, despite even extended negative-premium periods, small cap and value stocks have outperformed their counterparts over time, and when the premiums reversed, they often did so strongly and for multiple years.

  1. 1. US small cap is represented by the Russell 2000 Index; US large cap is the Russell 1000 Index; US value (marketwide) is the Russell 3000 Value Index; and US growth (marketwide) is the Russell 3000 Growth Index. US large value is the Russell 1000 Value Index; US large growth is the Russell 1000 Growth Index. Russell data © Russell Investment Group 1995–2016, all rights reserved.*All Charts by Dimensional Funds

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

 

2016: Ten Predictions to Count On

perdictionThe New Year is a customary time to speculate. In a digital age, when past forecasts are available online, market and media professionals find it harder to hide their blushes when their financial predictions go awry. But there are ways around that.

The ignominy that goes with making bold forecasts was highlighted in a recent newspaper article, which listed many bad calls US economists had made about 2015. These included getting the timing of the Federal Reserve’s interest rate increase wrong, incorrectly calling for a rise in long-term bond yields, and assuming an end to the commodity rout.1

For the broad US equity market, 22 strategists polled by the Wall Street Journal2 estimated an average increase for the S&P 500 of 8.2% for 2015. The most optimistic individual forecast was for a rise of 14%. The least optimistic was 2%. No one picked a fall. As it turned out, the benchmark ended marginally lower for the year.

In the UK, a poll of 49 fund managers, traders, and strategists published in early January 2015 forecast that the FTSE 100 index would be at 6,800 by midyear and 7,000 points by year-end. As it turned out, the FTSE surpassed that year-end target by late April to hit a record high of 7,103 before retracing to 6,242 by year-end.3

Australian economists were little better. The consensus view, according to a January 2015 Fairfax Media poll, was that local official interest rates would stay on hold all year. The Reserve Bank of Australia proved that wrong a month later, before cutting rates again in May.

It shouldn’t be a surprise that if economists can’t get the broad variables right, it must be tough for stock analysts to pick winners. Even a stock like Apple, which for so many years surprised on the upside, disappointed some forecasters last year with a 4.6% decline.4

In Australia, the “Top Picks for 2015” published by one media outlet a year ago included such names as Woodside Petroleum, BHP Billiton, Origin Energy, and Slater & Gordon, all of which suffered double-digit losses in the past year.5

It should be evident by now that setting your investment course based on someone’s stock picks or expectations for interest rates, the economy, or currencies is not a viable way of building wealth in the long term. Markets have a way of confounding your expectations. So a better option is to stay broadly diversified and, with the help of an advisor, set an asset allocation that matches your own risk appetite, goals, and circumstances.

Of course, this approach doesn’t stop you or anyone else from having or expressing an opinion about the future. We are all free to speculate about what might happen in the economy and markets. The danger comes when you base your investment strategy on such opinions. In the meantime, if you insist on following forecasts, here is a list of 10 predictions you can count on coming true in 2016:

  1. Markets will go up some of the time and down some of the time.
  2. There will be unexpected news. Some of this will move prices.
  3. Acres of newsprint will be devoted to the likely path of interest rates.
  4. Acres more will speculate on China’s growth outlook.
  5. TV pundits will frequently and loudly debate short-term market direction.
  6. Some economies will strengthen. Others will weaken. These change year to year.
  7. Some companies will prosper. Others will falter. These change year to year.
  8. Parts of your portfolio will do better than other parts. We don’t know which.
  9. A new book will say the rules no longer work and everything has changed.
  10. Another new book will say nothing has really changed and the old rules still apply.

You can see from that list that if forecasts are so hard to get right, you are better off keeping them as generic as possible. Like a weather forecaster predicting wind, hail, heat, and cold over a single day, your audience should prepare themselves for all climates.

The future is always uncertain. There are always unexpected events. Some will turn out worse than you expect; others will turn out better. The only sustainable approach to that uncertainty is to focus on what you can control.

In the meantime, let me wish a happy new year to you all.

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama,


1. Malcolm Maiden, “The Year Market Economists Failed to See Coming,” SMH, December 30, 2015.
2. “Strategists Expect Stocks to Keep Climbing in 2015,” Wall Street Journal, January 2, 2015.
3. “Five Fund Strategies to Ride Rising Markets,” The Times, January 3, 2015.
4. “Seven Stocks to Buy for 2015,” CNN Money, December 31, 2014.
5. “Top Stock Picks for 2015,” Motley Fool.

Second-Hand News

odds of successWhy doesn’t the media run more good news? One view is bad news sells. If people preferred good news, the media would supply it. But markets don’t see news as necessarily good or bad, rather in terms of what is already built into prices.

One academic study appears to confirm the view that the apparent preponderance of bad news is as much due to demand as to supply, with participants more likely to select negative content regardless of their stated preferences for upbeat news.1

“This preference for negative and/or strategic information may be subconscious,” the authors conclude. “That is, we may find ourselves selecting negative and/or strategic stories even as we state that we would like other types of information.”

So an innate and unrecognized demand among consumers for bad news tends to encourage attention-seeking commercial media to supply more of what the public appears to want, thus fueling a self-generating cycle.

Insofar as consumers of news are investors, though, the danger can come when the emotions generated by bad news prompt them to make changes to their portfolios, unaware that the news is likely already built into market prices.

This is especially the case when the notions of “good or bad” are turned upside down on financial markets. For example, stocks and Treasuries rallied and the US dollar weakened in early October after a weaker-than-expected US jobs report. Some observers said the “bad news” on jobs was “good news” for interest rates.2

Conversely, a month later, stocks ended mixed, bonds weakened, and the US dollar rallied after a stronger-than-expected payrolls number. While an improving job market is good news, it was also seen by some as cementing the case for the Federal Reserve to begin raising interest rates. In both cases, the important thing for markets was not whether the report was good or bad but how it compared to the expectations already reflected in prices. As news is always breaking somewhere, expectations are always changing.

For the individual investor seeking to make portfolio decisions based on news, this presents a real challenge. First, to profit from news you need to be ahead of the market. Second, you have to anticipate how the market will react. This does not sound like a particularly reliable investment strategy.

Luckily, there is another less scattergun approach. It involves working with the market and accepting that news is quickly built into prices. Those prices, which are forever changing, reflect the collective views of all market participants and reveal information about expected returns. So instead of trying to second-guess the market by predicting news, investors can use the information already reflected in prices to build diverse portfolios based on the dimensions that drive higher expected returns.

As citizens and media consumers we are all entitled to our individual opinions on whether news is good or bad. As investors, though, we can trust market prices to assimilate news instantaneously and work from there.

In a sense, the work and the worrying are already done for us. This leaves us to work alongside an advisor to build diverse portfolios designed around our own circumstances, risk appetites, and long-term goals.

There’s no need to respond to second-hand news.

1. Marc Trussler and Stuart Soroka, “Consumer Demand for Cynical and Negative News Frames,” International Journal of Press/Politics (2014).
2. Mark Hulbert, “How Bad News on Wall Street Can Be Good News,” WSJ MarketWatch (October 5, 2015).

 

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Dimensional Funds and  Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee. No offers may be made or accepted from any resident outside the specific state(s) referenced.

 

 

Which Hat Are You Wearing?

hatsMost of us have multiple roles—as business owners, professionals, workers, consumers, citizens, students, parents and investors. So our views of the world can differ according to whatever hat we’re wearing at any one time.

This complexity of people and their range of motivations, depending on their circumstances, highlight the inadequacy of cookie-cutter or automated investment solutions.

For instance, if you work for a taxi booking firm, you’re naturally going to take greater-than-usual interest in technology that allows consumers to book cabs directly. That’s because these new disintermediated services might affect how you make your living.

On the other hand, as a consumer you may welcome any initiative that increases competition, widens your choice and lowers prices.

As a taxpayer, you may look kindly on efforts to encourage user-pays systems in universities. But as a parent, you may be concerned about your teenage children taking on excessive debt to fund their education.

As citizens, we might champion a laissez faire approach to economic policy. But as investors, we may feel uncomfortable about certain policies and seek to express our values by placing limits on how our money is invested.

The point is everyone has the right to their own opinions and intelligent people can legitimately and respectfully disagree on many issues, including about what might happen in the world economy and about how policymakers should act.

The trick is in being clear with ourselves about which hat we are wearing when we make investment decisions and the trade-offs involved in reconciling our personal opinions with our desired investment outcomes.

For example, you may have an opinion on what central banks should do in normalizing interest rates. But do you really want to hang your decision about your portfolio allocation to longer-term bonds on your view of the interest rate outlook?

As a worker in an industry undergoing digital disruption, you may have an aversion to the technology putting you out of a job. But as an investor, do you want to forsake earning a share of the wealth from the new forces created by this disruption?

As a resident of a suburb near the airport, you may oppose on noise grounds a government decision to build a new runway, but as an investor and a worker you might benefit from the increased productivity generated by the investment.

The point is we have many roles in life and there often can be conflicts between our personal beliefs and opinions in one area with our desires in another.

Our strong view on the economic outlook may lead us to think the market will come around to pricing assets based on that opinion. But the power of markets is such that they reflect the views of millions of people, many of whom may hold contrary views.

Keep in mind, also, that competitors in those markets include professional investors with multiple sources of information and state-of-the-art technology. And even they have trouble getting these forecasts right with any consistency.

This isn’t to say we can’t invest based on our personal principles. But we first have to start from the assumption that in liquid markets competition drives prices to fair value. Prices reveal information about expected returns. That leaves us to diversify around known risks according to our own preferences and goals.

In short, life is full of trade-offs. It is the same in investment. We may pursue higher expected returns, but we want to do so without sacrificing diversification or cost.

The over-riding principle is to understand what we can and can’t control. We can have an opinion on government policy and we can express it through our vote, but we can’t control the investment outcome. We can have an opinion on what should happen to interest rates, but we can’t control what happens. So we diversify.

The role of a financial advisor is to help you understand these trade-offs and to separate opinion from fact, to balance your risk preferences with your desired wealth outcomes, and to accommodate your personal values within a diversified portfolio.

People with many hats require many different investment solutions. And that’s a good thing.

OUTSIDE THE FLAGS
By Jim Parker
Vice President
DFA Australia Limited

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Lion’s Share U.S. Financial Services and Cambridge are not affiliated. Indices mentioned cannot be directly invested in. Past performance is no guarantee.  When you access other linked websites, you assume total responsibility and risk of the websites you are linking to caveat emptor. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Article are provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services in Alabama, Florida, Georgia, and Tennessee.