I am in the process of writing a client update for clients reflecting on the past year and looking forward. The overall results have been pleasing with all major investment asset classes (barring cash) performing strongly.
If we look back at where we were at the beginning of January 2012 I think it would be fair to suggest that sentiment was poor. 2011 returns had been poor for everything other than bonds. There did not seem to be any major progress with the European debt crisis, growth was slowing in China and the US had only a few months previous been through a bruising political period culminating in the downgrade of the credit rating of US government debt. Not a great environment to provide confidence for the year ahead.
So why did things turn out so much better than what we might have expected?
The key driver in markets through 2012 seemed to be the hunt for yield underpinned by developments that were more positive than expected:
1) Increased Central bank stimulus measures including here in Australia.
2) The Chinese economy seems to have picked up after what appears to have been a stable political transition.
3) The US avoided the fiscal cliff ... for now.
4) Euro breakup fears eased after the head of the European Central Bank (ECB) Mario Draghi saying that the ECB will do whatever it takes to save the Euro
So what can we learn from the events of 2012?
Three really crucial lessons were evident for me:
1) Whilst current news might look negative (or positive), it's what happens next that is important for investment markets.
2) Trying to predict the next move for markets is very difficult.
3) The benefits from diversification are alive and well.
Jim Parker from Dimensional thrashes out these points in a little more details in his latest Outside the Flags article - Many Happy Returns. The article included some interesting data about returns from 20 developed markets and 20 emerging market some of which you might find surprising. I have included his article below.
Here's to a good year for 2013 hopefully with plenty of surprises on the upside!!
Regards,
Scott
The summer holiday season encourages media retrospectives about financial markets. It's fun to match these up with what people were saying a year before.
In December, 2011, the publication Barron's told investors to "buckle up". The consensus prediction of its panel of 10 stock market strategists and investment managers was for the US S&P-500 to end 2012 some 11.5% higher at about 1360. 1
"That sounds like a big gain, but a lot of things have to go right for the market to make such impressive headway," the writer said. "Even the most bullish of these Street seers fears stocks could be more wobbly in the next six months than in the six months past."
There was so much for forecasters to get right - a negotiation of the Euro Zone crisis, uncertainties over the growth of earnings, the roadblock of the US presidential election and the challenge for emerging economies to sustain high economic growth rates.
More than a year later, markets are still grappling with many of the same issues, though from different angles. Much of Europe is either in recession or growing only modestly, unemployment is high and a number of countries that share the single currency are unable to pay their debts. The US presidential election gave way to worries over the so-called "fiscal cliff", while Chinese exports have been hit by the slowdown elsewhere.
In the meantime, however, there have been solid gains in many equity markets, including parts of Europe and Asia, as well as North America. That Barron's panel forecast of the S&P-500 reaching 1360, which the magazine said was ambitious, turned out to be conservative. The index ended the year 13% higher at 1426. What's more, some of the strongest performances have been in emerging and frontier markets.
The table below shows performances for 2012 (to December 31) and annualised returns for the past three years of 20 developed and 20 emerging markets, using MSCI country indices. Returns are ranked on a year-to-date basis and expressed in Australian dollars.
Among developed markets, three members of the 17-nation Euro Zone - Belgium, Germany and Austria - were among the top performing equity markets last year. Leading the way among emerging markets was Turkey, which regained its investment grade ranking from agency Fitch in November.
While not one of the very top performers, the Australian market nevertheless delivered solid returns of 20% for the year despite the difficult international circumstances and the uncertainties at home over the extent of the slowdown in the domestic economy.
And while much of the media focus has been on the so-called BRIC emerging economies of Brazil, Russia, India and China, the real stars in the emerging market space these past three years have been the south-east Asian markets of the Philippines, Thailand and Indonesia.
There a few lessons from this. First, while the ongoing news headlines can be worrying for many people, it's important to remember that markets are forward looking and absorb new information very quickly. By the time you read about it in the newspaper, the markets have usually gone onto worrying about something else.
Second, the economy and the market are different things. Bad or good economic news is important to stock prices only if it is different from what the market has already priced in. My research colleague Jim Davis has done an interesting study on this. 2
Third, if you are going to invest via forecasts, it is not just about predicting what will happen around the globe. It also requires that you to predict correctly how markets will react to those events. That's a tough challenge for the best of us.
Fourth, you can see there is variation in the market performance of different countries. That's not surprising given the differences in each market in sectoral composition, economic influences and market dynamics. That variation provides the rationale for diversification - spreading your risk to smooth the performance of your portfolio.
So it's fine to take an interest in what is happening in the world. But care needs to be taken in extrapolating the headlines into your investment choices. It's far better to let the market do the worrying for you and diversify around risks you are willing to take.
In the meantime, happy new year and many happy returns!
