Returns were generally positive across markets in the first quarter and the strong performance in international markets was a nice change to see. The primary driver of performance at home and abroad continued to be the direct and indirect actions of central banks. The current degree of Federal Reserve watching and forecasting is reminiscent of the Alan Greenspan years when market participants attempted to guess policy decisions by studying the thickness of his briefcase prior to meetings.
Low interest rates dominated headlines in the bond market once again. For the first quarter of 2015, movement in short-term yields was negligible. The benchmark 10-yr Treasury Bond saw rates contract further during the quarter from 2.17% to 1.94%. And, long-term, 30 year US government bonds experienced a similar decline, dropping from 2.75% to 2.54%. The European Central Bank (ECB) introduced its own version of quantitative easing (the purchase of bonds in the open market) in March to fight off deflation just as the US Federal Reserve’s era of easy monetary policy inched closer to its long awaited end to be marked by an increase in interest rates. The launch of the ECB’s program compressed yields to historically low levels throughout Europe. As a result, investors searched for income elsewhere driving up performance in higher yielding and riskier areas of the bond market. Accordingly, safer and short-term bonds trailed their more risky counterparts but still managed to earn positive rates of return in the 1-2% range.
The US equity market ended the quarter up 1.80%, ending its streak of outperformance relative to markets abroad. Amongst the various segments of the US market, growth stocks continued to outperform value (i.e. cheaper) stocks while smaller companies outperformed larger companies. It’s worth noting that the Nasdaq index, which is dominated by technology companies, flirted with record levels that were last reached over 14 years ago at the peak of the dot-com era. The strength witnessed in international-developed and emerging markets was a welcome sight after their poor performance in 2014. Non-US developed equities posted returns of 6.10% while emerging markets earned 4.17% for the period. Both regions benefitted from the supportive measures introduced by key central banks as well as a less volatile US dollar. In addition, both domestic and international Real Estate Investment Trusts (REITs) continued their march upward, earning 5.61% and 2.84%, respectively, for the quarter.
Weak inflation and a strong US dollar were among the key economic themes in the first quarter of 2015. Central banks made it clear that they would do “whatever it takes” to reverse the low inflationary/deflationary environment and the aforementioned ECB policy is a perfect example of such actions. A large drop in energy prices and weakening global growth did not make the situation easier for policymakers. In the US, we actually experienced deflation of -0.1% for the 12 month period through February 2015 when accounting for energy prices. However, US job growth was positive but the upward trend slowed. As a result, the US Federal Reserve’s public statements have attempted to create more room for flexibility given the weak numbers while at the same time priming the market for a more immediate rate increase if economic data warrants such action. Greece remained a thorn in the side of European Union officials and a so called “Grexit” from the EU has become a very real possibility again. Nevertheless, the
ECB’s new monetary policies generated a feeling of optimism in the region. The movement in energy prices created very different outcomes in emerging markets. Energy importers, like India, benefitted from the lower prices while energy exporters, like Brazil and Russia, were negatively impacted. Elsewhere, growth in China has slowed and expectations have been lowered as a weak real estate market and high debt levels appear to be impacting the economy.
Weather vs. Climate
Many investors feel that they are not properly informed about the financial world unless they have checked daily, or even hourly, on how the Dow, S&P 500, or Nasdaq have moved in the intervening period.
In most cases, it’s a pretty harmless activity. It at least provides a bland conversation starter in fleeting social encounters, just as keeping up to date with tomorrow’s weather forecasts can fill an awkward silence.
But our very human focus on the day-to-day can often encourage us to make bad decisions that affect our long-term interests. That’s because while we live moment-to-moment, what often affects us most are imperceptible, gradual changes that occur over many years. Look at the way markets began 2015, as reflected in daily news headlines from Reuters:
• January 6: Wall St. in Longest Losing Streak in 13 Months
• January 8: Wall St. Jumps for Second Day, Helped by Economic Optimism
• January 14: US Stocks Fall Heavily on Growth Concerns
• January 20: China Seen Posting Weakest Growth in 24 Years
• January 20: UK Stocks Gain on China’s Growth
Trying to keep up with market sentiment based on news headlines is challenging. The China GDP story is a good example. The curtain-raisers announced it would be the weakest economic growth number for nearly a quarter century. And, sure enough, it was. But since the result was a fraction higher than what the market had priced, Asian stocks rallied.
As always, markets price expectations for events like this and then move if the outcome varies with what is in the price. It is hard enough for professional investors to keep track, never mind a layperson.
So, from minute to minute, market sentiment shifts in reaction to news - news about the economy, companies, governments and politics, and the wider world. Prices rise and fall in response to this news, which by definition is unpredictable.
To use an analogy, the market news is like the weather. One day it’s sunny. The next day it rains. It’s unseasonably warm one day but cool the next. The narrower your frame of reference, the greater the apparent variability.
Recent quarters along with the headlines listed are great anecdotal examples of such a comparison. Over the past twelve months portfolios that favored US equities over international markets performed well.
Since the beginning of 2015, the opposite is now true – international developed and emerging markets outperformed US markets. This underscores the fact that markets do indeed vary from day-to-day and even quarter-to-quarter.
If you take a step back and focus on a bigger frame of reference, you set yourself up to be more disciplined, understand the real drivers of wealth and have a much more pleasant and successful investing experience.
These two ways of looking at the markets (day-to-day vs year-to-year) are similar to the difference between the weather and the climate. The former changes constantly, the latter more gradually. With long-term investing, it’s the climate that you need to think about.
Such a practice is vital. It takes into account cumulative gains, actual trends and minimizes distractions. The media, by virtue of its publication schedule, must focus on the short-term and makes this difficult to accomplish. They need a different story every day. A practice that, more often than not, does not align with your best interests.
Adapted from “Weather vs. Climate” by Jim Parker, Outside the Flags column on Dimensional’s website, February 2015. Dimensional Fund Advisors LP (“Dimensional”) is an investment advisor registered with the Securities and Exchange Commission.