|Adapting to the "new normal"
Thursday November, 2011
When I started in the financial services 16 years ago with Investors
Group, we were taught from the beginning that stocks will always
outperform bonds and other forms of fixed income over the long
term (which most people agreed is a period of five years or
more). During my first five years in the business, that was
definitely true. But then the problems began.
The problems started in the autumn of 2000 after the high-tech
bubble burst and we experienced a correction of some magnitude.
That one took most investors between two and three years to
recover from. A few more years of decent gains were then offset
by the U.S.-led credit crisis in 2008, which was followed by
a nice recovery in 2009, allowing investors who stayed invested
to regain most, if not all of their money.
To sum up, not many investors made a lot of money except those
with good percentages in natural resources or precious metals
(fuelled mostly by Asian growth), which are two of the more
volatile sectors. Because of that, most people didn’t have more
than the recommended 10% to 15% cushion to protect again a meltdown
that never occurred. For that reason, the term “The Lost Decade”
was coined, and it’s not without merit.
The obstacles ahead
We are in the middle of two big problems. The U.S. problem
is “big,” because it’s the world’s largest economy. Americans
overspent and are trying to balance their finances, which may
take a few years. The housing market collapsed, especially in
certain states and areas (California, Michigan, Florida, Nevada
and Arizona were some of the hardest hit). This situation has
stabilized but is still years away from being normal. The other
big negative is high unemployment, which stresses government
benefit programs and finances and stops people from consuming
more or buying one of those cheap homes.
The second big problem is the sovereign debt disaster in Europe.
Getting 17 countries to agree on major changes isn’t easy. The
U.S. is a single country, so nearly all of its problems are
internal ones, with the roadblocks being the political process.
Europe, on the other hand, has a number of countries that need
some major restructuring. But years of government largesse (funded
by borrowed money) have insulated populations of most peripheral
southern European nations from economic realities. Now, no one
wants to do the same government-guaranteed job for less money
or have their government-guaranteed benefits packages or pensions
reduced. Yet those are precisely the kinds of drastic actions
that are needed for countries like Greece, Spain, Portugal,
and now Italy, to get back to some sort of fiscal balance. I
believe Europe will take the necessary steps to climb out of
this, but it won’t be pretty or quick.
What’s the good news?
The good news is that China, India, and other emerging markets
have mostly burgeoning economies with good growth rates and
much younger populations that are far away from retirement age.
There is some inflation risk as a result, but so far, China
and India have proven to be fairly adept at managing monetary
and debt risks through various growth stages.
The big question is whether this good news will be enough to
offset the doom and gloom from the U.S. and Europe. So far,
it’s been a saw-off, with stock markets reacting to the unfolding
eurozone crisis with daily gyrations of hundreds of points in
many cases, as one crisis begets a “solution” only to be supplanted
by another crisis.
Volatility has increased
My educated guess is that we may see a “range-bound” market
for a few years. Volatility will continue to be higher than
average. From June 2003 to June 2007(1,007 trading days), only
six days saw the S&P 500 Composite Index experience moves
of +/- 2%. That period was a period of extremely low volatility.
But from June 2007 to June 2011 (1,009 trading days), the S&P
500 saw 166 days where the index moved +/- 2%, which was a massive
When I started in this business, you could diversify a client’s
portfolio geographically, which helped “smooth the ride.” As
world economies have become more closely tied, this strategy
hasn’t been effective at reducing the volatility of portfolios.
Major world stock indexes seem to be more and more closely correlated,
and I don’t see that changing. All that means is that one tool
has been removed from our toolbox, and we must use other methods
to reduce volatility and increase returns.
What to do?
For every market condition, there are strategies we can employ
to take advantage of the prevailing conditions at that time.
What once worked may not be effective today or in the foreseeable
future. I will explore some of those strategies in my next column,
including a fresh look at diversification, the benefits of disciplined
and regular investment, and the “marathon” mindset.
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Personal Opinions & Recommendations Disclaimer
The foregoing is for general information purposes only and is the
opinion of the writer. This information is not intended to provide
specific personalized advice including, without limitation,
investment, financial, legal, accounting or tax advice. However,
please call the author to discuss your particular circumstances.