Yea, all which it inherit, shall dissolve,
And, like this insubstantial pageant faded,
Leave not a rack behind. We are such stuff
As dreams are made on; and our little life
Is rounded with a sleep.
The Colorado Shakespeare Festival is now in full swing featuring performances of the Merry Wives of Windsor, the Tempest, and Henry IV – Part I. The festival, which launched in 1958, has become a quintessential summertime event in Boulder, and its performances never fail to provide nuanced views on life, love, and human folly.
On that note, there may be no better example of human folly than investor behavior . . . or perhaps investor misbehavior. Global equity markets continued their slow and steady march upwards during the second quarter, and have added to those gains since. The MSCI All-Cap World Index has gained 7.25% year-to-date through July 25th, led by gains in the US and – refreshingly – emerging markets. Despite these returns, investor optimism and pessimism permeate the markets – with each opposing viewpoint held with unreasonable conviction.
The Tweet below provides a cogent and insightful summary of the Optimistic perspective.
Indeed, US corporate profit margins remain at or near all-time highs; corporate and consumer balance sheets are dramatically improved and loan growth is accelerating; US unit-labor costs are compellingly lower compared to their European and Japanese peers; the US energy renaissance is proving a significant competitive advantage; and US economic growth – though fitful and sub-par compared to prior recoveries – has been steadily chugging along at a 2% yearly clip. With second quarter corporate earnings season well underway, the results thus far have been impressive – the best ratio of earnings beats in 15 quarters. Let the good times roll, right? Not so fast . . .
The pessimists can also mount an effective case for gloom ahead. Beyond the obvious geopolitical tensions in the Ukraine, Iraq, and Israel; stock valuations appear stretched by historical standards – especially US small cap and utilities; wage growth has been stagnant and anemic; employment gains have been largely driven by unprecedented declines in the labor participation rate; and volatility is trending at troublingly low levels near the bottom 1% of historical measures.
Concurrently, after literally years of sitting in cash on the sidelines, retail investors have rediscovered their fondness for stocks, pouring roughly $100 billion into stock funds – 10 times as much as during the previous 12 months and a stark reversal from the five-year period between 2007 and 2012 when investors withdrew about $300 billion from stock funds.
One of BSW’s primary investment mandates is to help our clients avoid the common errors caused by greed or fear overpowering rational decision making. A stark example of these errors was cited in some excellent research on the actual returns of the average fund investor versus the actual returns of the investment fund itself over time. This “investor behavior penalty” is substantial – more than 6% annually over a 20-year period – and results from, among other things, chasing returns, trading in and out of “hot managers,” and most importantly, not sticking to an allocation plan in both good and bad times.
With this “investor behavior penalty” as backdrop, please recall that we recently rebalanced portfolios to harvest gains on winners and bolster positions we feel offer better relative value – such as energy, dividend-paying Asian companies, international small-cap, and US large cap growth. With US indices at or near all-time high, prudence dictated booking some profits and rebalancing your portfolio to its macro-allocation targets.
Looking ahead, we believe that US economic growth will continue and (hopefully) catch up to US equity valuations, allowing for continued modest gains supported by low (but rising) inflation and ongoing accommodation from the US Federal Reserve. Abroad, we believe that European companies are due for earnings-driven gains and that emerging markets, especially Asia, have found a footing and are attractively priced. Finally, we believe that volatility’s eerily low levels are unlikely to persist. Increased market turbulence from these readings are not just possible, but a given. As such, we will continue to look for opportunities to harvest gains on outperforming positions to rebroadcast across portfolios as warranted.
We hope this Update & Commentary provides you with better insight into your BSW Growth Portfolio — and many thanks for reading. If you would like to discuss your portfolio in greater detail, please don’t hesitate to contact BSW. As always, we are happy to help.
-David Wolf, Chief Investment Officer