I just wanted to send a quick note about the recent volatility in the global markets. We’ll see where today’s markets end up, but as I am writing this email we’re down around 2% in the US and the European markets are off even more. We may be seeing something we’ve seen time and again where the small investor, after having just gotten back in the market following a significant upward movement off of last year’s lows, gets hammered in yet another sell-off. The small, do-it-yourselfer will get scared all over again and sell after losing another 3-5% of his assets and not get back in until the markets mostly recover. We see it every time the markets correct and fickleness behind those who don’t have someone providing objective advice is probably the most significant cause of wealth deterioration in the public markets. So let me offer some objective advice…
First, a word or two about what is likely going on. While most of the economic data out of the US has been positive, we are still missing the all important recovery in jobs, income, and housing. The productivity numbers and early signs of business spending are real, but the increased spending by consumers can evaporate as quickly as it returned and there is still a real concern that housing foreclosures are going to increase in a major way. While most think a broad recovery is underway (I include myself in this group), it is still in its infancy, is very tenuous, and the markets know it. But while we may see a light at the end of the tunnel here in the US, we’re seeing serious signs of weakness in sovereign debt over in Europe and there are significant concerns that Greece will eventually go bankrupt and other countries may soon follow: Spain, Portugal, Italy, and yes, even the UK is being included in the group of contagion concerns because of its fiscal imbalances.
The situation in Europe is what has me most concerned, and trouble there is most definitely causing trouble here in the US markets. We could be at the beginning of an overall unraveling of the European Union, although I expect that is highly unlikely. Nevertheless, it is concerns such as these that are likely driving the markets lower and it may take a while for them to calm down again since the trouble in Europe will take considerable time to figure out.
However, “sell in May and go away” is not the solution. While it will likely appear to be the right call many times over the course of the summer, remember that getting out of the markets always involves the dilemma of when to get back in. Let me tell you from experience that knowing either side of that decision with any certainty is practically impossible and any true investment professional will agree with me wholeheartedly. The better solution, and what we already have in place here at Frontier, is to have your portfolio properly allocated so that the risks to the most dangerous areas of the global marketplace are reduced and you have some form of protection against an equity sell-off via bonds. Our equity portfolios are and have been underweight Europe since we launched last year, and our current weighting in Greece (within equities) is almost non-existent at around 10 basis points, or one tenth of one percent of the equity portfolio. The MSCI All Country World Index (MSCI ACWI) at the end of March had a weighting in Europe of nearly 27% but ours was at 15%. The underweight in Europe needs to be accounted for elsewhere, of course, and our portfolios have overweights relative to the MSCI ACWI in both the US and the Emerging Markets. So while we clearly have our own risks to confront, we think they are much wiser given the state of the global economy and what we think are the true opportunities over the next 3-5 years.
And do not forgo your bond allocation. Unfortunately it is a very uncomfortable time within fixed income, too. Treasury bond-watchers are waiting for a sell-off any day due to our own fiscal imbalances here in the US, and it seems no one is comfortable with the status of the municipal bond markets, either, since many states are near bankruptcy themselves. And forget about investing in sovereign debt since that is the main cause of the trouble with European equities! Nevertheless, bonds and stocks to continue to offer a certain amount of low and even negative correlation so it is important to maintain the overall target allocation between stocks and bonds during turbulent markets. For fixed income, Frontier clients are strictly in US bonds since I prefer to leave international risks to the equity portfolio, and within the US bond markets I feel that municipal debt is the better place to be right now due to higher yields per equivalent credit quality. While the risk of default has increased relative to history, I’m still comfortable enough with the high quality US bond sectors overall.
So stay in the markets but continue to monitor your portfolio so that you can take advantage of any rebalancing opportunities that might present themselves as the markets gyrate. No one said investing is easy, but staying on top of things and remaining unemotional will pay off in the long run.