RSS!    Full Post
Share Third Quarter Market Commentary -- Chaos at Quarter's End

We are again fortunate to report that while the third quarter was a volatile one, stocks ended higher than where they started.  Overseas shares did better than domestic ones for the first time in quite awhile.  And while emerging market stocks were as usual, the most volatile, they too ended the quarter with better returns than the S&P500.  The diversification that we have implemented in client accounts is now not only a risk management exercise, it is also adding to returns.  Over the long term, availing ourselves of a broader range of opportunities should pay financial dividends. 

Bonds, meanwhile, have had a tougher year.  With interest rates generally rising on the longer end of the yield curve, bonds have posted their first negative returns in more than five years.    Still, the third quarter saw yields fall back and bond prices rebound.  Concerns that the Federal reserve will start tightening monetary policy were perhaps a bit premature.  Unemployment still remains stubbornly high, and inflation rather low.  The Fed is targeting both of these indicators and sees no immediate need to curtail its bond buying activities. 

As I write this, all eyes are on our dysfunctional institutions in Washington.  The current government shutdown, while not unprecedented, does subtract from economic growth.  People without paychecks must curtail personal spending, which ripples through the economy by affecting those firms for whom they are customers.  At least concerns of an outright default on the government’s debts have been squashed.  This would have catastrophic consequences for interest rates and growth around the world, and sends the completely wrong signal about our country’s creditworthiness. 

We are encouraged to see US economic growth maintained despite the “sequester”.  This is the first time in the past 50 years that a recession has been met with reduced government spending so early in the recovery.  Europe is also starting to see the light of day, and new policies in Japan have given hope that the Land of the Rising Sun will also see economic expansion and an end to the deflationary spiral that has so plagued that nation. 

We never forget that investing in stocks is about companies, not markets...  And companies are more resilient than are the investors who buy their shares.  A historical perspective shows that the most important factor in generating returns is the price that an investor pays.  (Not politics or economic growth or anything else.)   In other words, the year that you start investing is more important over the long term than which stock you pick. (So, there is some luck in there, too.)  If this is true, then the corollary is also true:  Being steady in times of uncertainty, and buying when one is most fearful, is the activity that will most reward you over the long term…   THAT, is making your own luck. 

Since price is the most important factor, how would we characterize today’s prices?   First of all, we are not at any extreme level; neither cheap, nor expensive, relative to history.  European shares are a bit less expensive than their American counterparts.  And emerging market companies, if one could generalize across dozens of volatile nations, are cheaper still. 

One firm whose work we follow is Boston-based Grantham, Mayo, Van Otterloo & Co., or “GMO”.  GMO has a very long term perspective and creates 7-year forecasts for a dozen asset classes.  Their research suggests that, over this seven-year forecast period, higher quality domestic shares (those with the strongest balance sheets) should outperform smaller companies and lower quality large firms.  They also see international shares having an advantage over domestic ones.  Emerging markets companies, by their calculations, should outperform them all by the year 2020.  Our portfolios allocations are generally in line with these projections.

These past five years have been uncertain times, but we have tried to keep our clients focused on longer term issues.  With the Dow Industrials at 15000, investors have clearly been rewarded when they have ignored the headlines, pundits and talking heads.  There will again be negative markets and significant volatility.  But we are investing in companies that have survived, sometimes for more than 100 years.  They are run by experienced management teams that may make mistakes, but as a group are well equipped to navigate tough times as well as the good ones.