As of July 31, 2015, the S&P 500 had made a new high in 23 out of the previous 36 months (calculated by monthly total return; data is from Morningstar). Then suddenly, the index lost 11.13% from August 18 to August 25. Reports of volatility’s demise were greatly exaggerated.
Seven years removed from the financial crisis, we do not believe that the core issue (excessive debt) has ever been fundamentally addressed. Instead, the debt has been shifted to governments, and extraordinary monetary policy has been introduced in an attempt to resuscitate economic growth. Ultra-low interest rates have served to inflate stock prices, resulting in large gains for those willing to take the risk. We have taken a more cautious approach: employing mutual fund managers who buy potentially undervalued companies when they are available and holding cash when opportunities are scarce. This has obviously proved less rewarding for the time being than simply owning the market. Still, investing in every company out there, with no thought to profitability or risk (i.e. indexing), strikes us as a dangerous proposition given the confluence of high debt, high asset prices and central bank uncertainty.
As can be seen in the chart below, stocks have been on an upward march for most of the last twelve months. Admittedly, our funds did not participate much in this rally. Though disappointing, this was not entirely surprising. We do believe however that the funds held up relatively well in the downdraft since mid-August.
*As represented by 20% Russell 1,000, 20% Russell 2,000, 30% MSCI EAFE, 30% MSCI ACWI
Recent events have been a reminder that markets do not always go straight up. We do not know whether this is actually the beginning of a significant downturn or merely a bump on the road to a new high. We remain convinced however that ours is a prudent strategy for such a time as this.
Aaron Pettersen, CFA, CFP®