Monday, August 31, 2015

The Patience Principle

Jim Parker
Outside the Flags
Vice President














Global markets are providing investors a rough ride at the moment, as the focus turns to China’s economic outlook. But while falling markets can be worrisome, maintaining a longer term perspective makes the volatility easier to handle.

A typical response to unsettling markets is an emotional one. We quit risky assets when prices are down and wait for more “certainty.”

These timing strategies can take a few forms. One is to use forecasting to get out when the market is judged as “overbought” and then to buy back in when the signals tell you it is “oversold.”

A second strategy might be to undertake a comprehensive macro-economic analysis of the Chinese economy, its monetary policy, global trade and investment linkages, and how the various scenarios around these issues might play out in global markets.

In the first instance, there is very little evidence that these forecast-based timing decisions work with any consistency. And even if people manage to luck their way out of the market at the right time, they still have to decide when to get back in.

In the second instance, you can be the world’s best economist and make an accurate assessment of the growth trajectory of China, together with the policy response. But that still doesn’t mean the markets will react as you assume.

A third way is to reflect on how markets price risk. Over the long term, we know there is a return on capital. But those returns are rarely delivered in an even pattern. There are periods when markets fall precipitously and others when they rise inexorably.

The only way of getting that “average” return is to go with the flow. Think about it this way. A sign at the river’s edge reads: “Average depth: three feet.” Reading the sign, the hiker thinks: “OK, I can wade across.” But he soon discovers the “average” masks a range of everything from 6 inches to 15 feet.

Likewise, financial products are frequently advertised as offering “average” returns of, say, 8%, without the promoters acknowledging in a prominent way that individual year returns can be many multiples of that average in either direction.

Now, there may be nothing wrong with that sort of volatility if the individual can stomach it. But others can feel uncomfortable. And that’s OK too. The important point is being prepared about possible outcomes from your investment choices.

Markets rarely move in one direction for long. If they did, there would be little risk in investing. And in the absence of risk, there would be no return. One element of risk, although not the whole story, is the volatility of an investment.

Look at a world stock market benchmark such as the MSCI World Index, in US dollars. In the 45 years from 1970 to 2014, the index has registered annual gains of as high as 41.9% (in 1986) and losses of as much as 40.7% (2008).

But over that full period, the index delivered an annualized rate of return of 8.9%. To earn that return, you had to remain fully invested, taking the unsettling down periods with the heartening up markets, but also rebalancing each year to return your desired asset allocation back to where you want it to be.

Timing your exit and entry successfully is a tough task. Look at 2008, the year of the global financial crisis and the worst single year in our sample. Yet, the MSCI World index in the following year registered one of its best ever gains.

Now, none of this is to imply that the market is due for a rebound anytime soon. It might. It might not. The fact is no one can be sure. But we do know that whenever there is a great deal of uncertainty, there will be a great deal of volatility.

Second-guessing markets means second-guessing news. What has happened is already priced in. What happens next is what we don’t know, so we diversify and spread our risk to match our own appetite and expectations.

Spreading risk can mean diversifying within equities across different stocks, sectors, industries, and countries. It also means diversifying across asset classes. For instance, while stocks have been performing poorly, often bonds have been doing well.

Markets are constantly adjusting to news. A fall in prices means investors are collectively demanding an additional return for the risk of owning equities. But for individual investors, the price decline, if temporary, may only matter if they need the money today.

If your horizon is five, 10, 15, or 20 years, the uncertainty will soon fade and the markets will worry about something else. Ultimately, what drives your return is how you allocate your capital across different assets, how much you invest over time, and the power of compounding.

But in the short term, the greatest contribution you can make to your long-term wealth is exercising patience. And that’s where your advisor comes in.


Global markets are providing investors a rough ride at the moment, as the focus turns to China's economic outlook. But while falling markets can be worrisome, maintaining a longer-term perspective makes the volatility easier to handle.

https://www.dimensional.com/

Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. There is no guarantee investment strategies will be successful. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors.

Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.

Monday, August 24, 2015

Market Volatility


Pathways Advisory Group, Inc.
Jeff Karst, CFP®













Today (Monday, August 24, 2015) the S&P 500 closed at 1893.21 (down 237.61 from its peak close of 2130.82 on May 21, 2015).  That’s a drop of more than 11% this year.  How “normal” is it for the S&P 500 to drop this much during the year?  It turns out that over the past 35 years, the average intra-year decline is 14.2%.  See chart below.  Turns out that significant drops are normal.


If this sounds familiar to you, it’s because we first wrote about it in Are Market Declines Normal? in September 2011.

Prior to the past couple of weeks, the stock market has been somewhat quiet.  There have been small ups-and-downs but it’s been slightly positive (before the last couple of weeks).  This recent volatility may have you thinking that we should do something.  But, we cannot predict the future.  This is why our advice has always been (and will always be) to just stay invested.

The following chart shows the importance of staying invested.  For the 20-year period ending 12/31/14, the S&P 500 returned 9.85%.  By missing the 10 best days during that time period, your return would be cut by almost 40%!


In order to obtain what is rightfully yours as an investor (market returns), you must stay invested.  If you attempt to make adjustments, research has shown that the average investor will lose.  We wrote about that research study in Investment vs Investor Returns.

We have the same story all the time – stay invested, think long-term.  If you think it’s boring, you’re right!  We like to be boring.  See Dustin’s article How Boring!

Find Jeff on
https://www.linkedin.com/in/jeffkarst

Friday, August 14, 2015

The China Syndrome

Jim Parker
Outside the Flags
Vice President














The recent severe volatility in China’s share markets has raised questions among many investors about the causes of the fall and the wider implications for the global economy and markets.

The Shanghai Composite Index—the mainland stock market barometer and one dominated overwhelmingly by retail investors—more than doubled during the year from mid-2014, only to lose more than 30% of its value between mid-June and mid-July this year.

The volatility was much less in Hong Kong, where foreign investors tend to get their exposure to China. The Hang Seng Index fell about 17% from April’s seven-year high, though it had a more modest run-up in the prior year of about 25%.

Nevertheless, the speed and scale of the fall on the Chinese mainland markets unsettled global markets, fuelling selling in equities, industrial commodities, and allied currencies like the Australian dollar and buoying perceived safe havens such as US Treasuries and the Japanese yen.

The decline in Chinese stocks triggered repeated interventions by China’s government, which has been seeking to transition the economy from a long-lasting, export-led boom toward more sustainable growth based on domestic demand.

Investors naturally are concerned about what the volatility in the Chinese market means for their own investments and what it might signify for the global economy, particularly given the rapid growth of China in the past 20 years.

SHARE MARKET VS. ECONOMY

Measured in terms of purchasing power parity (which takes into account the relative cost of local goods), the Chinese economy is now the biggest in the world, ranking ahead of the US, India, Japan, Germany, and Russia.1

Yet China’s share market is still relatively small in global terms. It makes up just 2.6% of the MSCI All Country World Index, which takes into account the proportion of a company’s shares that are available to be traded by the public.

The Chinese market is also not a large part of the local economy. According to Bloomberg, it is capitalized at less than 60% of the country’s GDP. By comparison, the US total equity market is capitalized at more than 100% of US GDP as of July 2015, according to Bloomberg.

China is classified by some index providers as an emerging market. These are markets that fall short of the definition of developed markets on a number of measures such as economic development, size, liquidity, and property rights.

China’s stock market is still relatively young. The two major national exchanges, Shanghai and the southern city of Shenzhen, were established only in 1990 and have grown rapidly since then as China has industrialized.

With foreign participation in mainland Chinese markets still heavily restricted, many foreign investors have sought exposure to China through Hong Kong or China shares listed on the New York Stock Exchange.

As a consequence, domestic investors account for about 90% of the activity on the Chinese mainland market. And even then, the participation is relatively narrow. According to a China household finance survey, only 37 million, or 8.8% of Chinese families, held shares as of June 2015.2 As a comparison, just over half of all Americans own stocks, according to Gallup. In Australia, the proportion is 36%.

While the Chinese stock market is about 30% off its June highs, it nevertheless was still about 70% higher than it was 12 months before, as of late July 2015. As such, much of the pain of the recent falls will have been felt by people who entered the market in the past year.

A final point of perspective is that while the Chinese economy has been slowing, it is still expanding at around 7% per annum, which is more than twice the rate of most developed economies.

The IMF in April projected growth would slow to 6.8% this year and to 6.3% in 2016. Still, it expects structural reforms and lower oil and commodity prices to expand consumer-oriented activities, partly buffering the slowdown.3

While such forecasts are subject to change, markets have priced in the risk of a further slowdown to what was previously expected, as seen in the renewed fall in the prices of commodities like copper and iron ore, which recently hit six-year lows.

DRIVERS OF THE BOOM

The Chinese share market boom of the past year cannot be attributed to a single factor, but certainly two major influences have been the Chinese government’s promotion of share ownership and investors’ increased use of leverage.

The government has been seeking to achieve more sustainable, balanced, and stable economic growth after nearly four decades of China notching up heady annual growth rates averaging 10% on the back of an official investment boom.

But the transition to a shareholding economy has created its own strains. The outstanding balance of margin loans on the Shanghai and Shenzhen markets grew to 4.4% of market capitalization by early July, according to Bloomberg.4

Under a margin loan, investors borrow to invest in shares or other securities. While this can potentially increase their return, it also exposes them to the potential of bigger losses in the event of a market downturn.

When prices fall below a level set by the lender as part of the original agreement, the investor is called to deposit more money or sell stock to repay the loan. These margin call liquidations can amplify falling markets.

Chinese regulators, mindful of the potential fallout from the stock market drop, have instituted a number of measures to curb the losses and cushion the impact on the real economy.

These have included a reduction in official interest rates, suspension of initial public offerings, and enlisting brokerages to buy stocks backed by cash from the central bank. In the latest move, regulators banned holders of more than 5% of a company’s stock from selling for six months.

The government also has begun an investigation into short selling, which involves selling borrowed stock to take advantage of falling prices. In the meantime, about half of the companies listed on the two major mainland exchanges were granted applications for their shares to be suspended.

While such interventionist measures may seem alien to people in developed market economies, they need to be seen in the context of China’s status as an emerging market where governments typically play a more active role in the economy.

Whether the intervention works in the long term remains to be seen. But the important point is that this is a relatively immature market dominated by domestic investors and prone to official intervention.

SUMMARY

The re-emergence of China as a major force in the global economy has been one of the most significant drivers of markets in the past decade and a half.

China’s rapid industrialization as the population urbanized drove strong demand for commodities and other materials. Investment and property boomed as credit expanded and people took advantage of gradual liberalization.

Now, China is entering a new phase of modernization. The government and regulators are seeking to rebalance growth and bring to maturity the country’s still relatively undeveloped capital markets.

Nevertheless, China remains an emerging market with all the additional risks that this status entails. Navigating these markets can be complex. There can be particular challenges around regulation and restrictions on foreign investment.

We have seen those risks appearing in recent weeks, as about a third of the sharp rise in the Chinese mainland market over the previous year was unwound in a matter of weeks, prompting intense government intervention.

Markets globally are weighing the wider implications, if any, of this correction. We have seen concurrent weakness in other equity markets and falls in commodity prices and related currencies.

Yet it is important to understand that the stock market is not the economy. China’s market is only about 2.6% of global market cap and its volatile mainland exchanges are, for the most part, out of bounds for foreign investors anyway.

For individual investors, the best course in this climate, as always, is to maintain diversification and discipline and remember that markets accommodate new information instantaneously.

1. IMF World Economic Outlook, April 2015.

2. “China Households Raise Housing Investment in Q2,” Reuters, July 9, 2015.

3. IMF World Economic Outlook, April 2015.

4. “China’s Stock Plunge Leaves Market More Leveraged than Ever,” Bloomberg, July 6, 2015.



Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services. 


Monday, August 3, 2015

The Financial Crisis in Greece

Weston Wellington
Down to the Wire
Vice President
















  Last week we posted Jim Parker’s article “Greece is the Word”.  Mr. Parker focused on the relatively small size of Greece in economic terms.  The following video by Weston Wellington offers some additional insight on why we shouldn’t change our investment strategy based on Greece.



Source: https://www.dimensional.com/ 

https://www.dimensional.com/






Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.