Here we are for a third year running, with markets being whipped around during early summer due to European debt issues and their potential contagion effects.
Following a strong start to the year, equity markets have given back the majority of first quarter gains during April and May.
However, while 2010 and 2011 saw 16% and 19% market declines (see Chart I below), we expect 2012 to have a smaller trough given the market’s greater awareness of the issues at hand (surprises tend to affect the markets more).
Chart I – S&P 500 Pullbacks Due to EU Debt Issues in Last Three Years
While there are no guarantees the decline will indeed be smaller, one of the market sentiment indicators we regularly track is in extreme oversold territory, and suggests that a rebound is either already in progress off the recent low on May 21st, or it will soon begin (see Chart II below).
Chart II – Investor Crowd Sentiment at Oversold Levels (Expect Rebound Soon)
However, any market rebound will require significant resolution of debt issues in Europe (specifically in relation to Greece) to ensure its durability. We recognize that it can be frustrating when unresolved economic issues continually resurface, impacting current returns.
Just when it appears that certain issues are on track for resolution, they rear their ugly heads again. Furthermore, when many of these issues are out of your control, it can be doubly frustrating.
Managing Risk in Turbulent Times
During turbulent times, we focus heavily on risk management and staying within our client’s individually-defined levels of volatility tolerance. For all our clients, and for all our twenty-six (26) different portfolios, we are within these levels and manage them closely every day.
While recent returns may be frustrating, our focus on risk management allows clients to stay the course, and for us to position portfolios for the next major bull market (timing TBD).
Economies and stock markets have stagnated many times before, and they always emerge stronger once the storm passes. Large rewards lie ahead for those who faithfully continue to save and to invest in diversified portfolios.
As an example, Emerging Markets (EMs) are growing 3-4x faster than Developed Markets, but have declined far more heavily during the EU crisis of the past three years.
These EM declines have resulted in valuation levels near those at the depths of the bear market in March 2009 (e.g. EM price-to-earnings ratios are 38% lower than those in the US), despite superior current and projected growth.
As EU uncertainties are resolved, EMs should experience the mother-of-all bull markets, as millions of people continue to be pulled out of poverty and brought into the middle class.
As is the case with any of life’s pursuits, investing will always include a combination of successes and setbacks, it is not a straight line exercise.
The winners continually push forward, focus on the actions they can control and need to execute (saving, investing, managing risk), and maintain their belief.