One of the most popular phrases on Wall Street this spring was “no place to hide.”
Whether you invested in stocks, real estate, commodities or high-grade or junk bonds, you probably won’t be happy with your second-quarter portfolio report.
Within and among broad investment categories, domestic and international, almost nothing worked, except short-term fixed-income funds.
It was enough to give diversification a bad name. The notion that you can offset losers with winners by holding investments globally across multiple types of investing didn’t work.
“The world is flat,” veteran Chicago money manager Rob Lyon, chief investment officer of Institutional Capital Corp., told the annual Morningstar investment conference here last week.
But his observation about the harmonies of globalization took on an unfortunate meaning this spring, largely because central banks in the United States, Europe and Asia moved in concert to withdraw easy money from their economies, taking the fizz out of the punch.
Federal Reserve Board Chairman Ben Bernanke was booed on Wall Street and Main Street as he pushed U.S. interest rates higher in his first three policy meetings as chief. But the Bank of Japan is just beginning to talk about tighter credit, and the European Central Bank appears to be midstream in its rate hikes.
Realization that the international cheap money party was ending hit investors of all sorts, mostly at the same time in early May. Price declines ranged from a 26 percent loss for emerging-market stocks to an 8 percent loss for the Standard & Poor’s 500 index of major U.S. firms.
The Dow Jones/AIG commodities index fell 11 percent. Small-company U.S. stocks and major non-U.S. stocks dropped at nearly the same rate–about 15 percent. Japanese stocks dropped 19 percent (from April 7).
Oddly, of all of these major financial indicators hit their current low on the same day–June 13, a day without any major financial news.
The lock-step behavior was evident on the upside, as well. Stock, bond and commodity prices rose around the world in the 24 hours after the Federal Reserve hinted that it might suspend its rate increases after last Thursday’s increase.
“They’ve been correlated on the way up, just as they’ve been correlated on the way down,” market analyst James Bianco of Bianco Research in Chicago told a recent client conference call. “This is an unusual pattern that people have a hard time grasping.”
The uniform behavior of global markets is likely to persist, especially as long as central banks are unified in managing liquidity–the availability of low-cost money.
“Liquidity drives asset prices, and the Fed is the prime generator of liquidity in the world,” Lyon said in an interview. “Things go off track at various times, but generally speaking when the Fed is easing most assets are going to be appreciating, other than high quality bonds, and vice versa.”
Moreover, the evolution of homogenized economies, with uniform technology access, easier flows of capital across the globe and expanding middle classes, means that the ebb and flow of winners and losers among categories of investment and across borders will be harder to discern, let alone predict.
National political developments, natural disasters, isolated pockets of speculation–such factors will disrupt the uniformity of market trends.
Don’t expect lock-step directional moves–up or down–in all your investments all the time, but “on a going-forward basis, the returns are going to be more correlated.” Lyon said. “That isn’t the way the world acted in the 1980s and 1990s.”
The correlation of markets has been increasing for several years, especially as the Fed and Asian central banks acted more closely in concert in the wake of Asian financial crises in 1997 and 1998. Indeed, 2002 was the last year when you could have significantly offset a decline in stock prices with an increase in commodity prices.
As long as the availability of cheap money, rather than the outlook for economic growth and corporate profits, is the locomotive of financial markets, “it doesn’t matter if you’re holding the 10-year [Treasury] note, copper, or health-care stocks. They’re all going to move up and down together,” Bianco said.
As a result, your mid-year portfolio review probably needs to add two questions, centered on the themes of market volatility and diversification.
Is the investment you bought to offset the likely ebb and flow of another investment actually performing as you intended? If not, do you have another reason to own this pair of investments?
Lyon noted that the storied hedge fund, Long Term Capital Management (LTCM), nearly went bust in 1998 because the fund’s highly credentialed fund managers failed to spot this problem. “You don’t want to be an individual example of LTCM,” Lyon said.
What is the riskiness of each investment, measured by the frequency and amplitude of its price volatility, up and down?
“If you spread your assets around and you’re investing in a broad-based fund or in several different markets, that volatility can be diversified away,” Raymond Mills, manager of the T. Rowe price International Growth & Income Fund, said in a recent report to clients.
This is a different process than trying to offset winning and losing market cycles and strong versus weak national economies. For example, balancing an emerging-markets fund with a micro-cap U.S. stock fund looks like diversification, but your risk in both categories is well above average.
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bbarnhart@tribune.com
