Like most years, 2013 will leave behind its winners and its losers. Stock market participants were (for the most part) rewarded for their bullishness, especially those who have been overweighted to US stocks. Even owners of European stocks had an excellent year, which may surprise you given the mostly bad news we’ve been hearing about the financial condition of European countries. Emerging markets, however, were not as kind to investors and have been basically treading water for 3 years now since their incredible two-year recovery from the 2008-2009 bear market. Investors in fixed-income (bond) and hybrid (convertible bonds, MLPs, commodities, etc.) also had a rough time for much of 2013.
2013 YTD (as of 12/23/13) performance (by asset class):
So why not invest only in US stocks?
I’ve been asked a few times recently—given how significantly US stocks have outperformed the rest of the world over the past year—why even bother investing in other regions of the world? The answer to this question boils down to two basic investment principles: diversification and not chasing performance.
Followers of our newsletter know that diversification allows an investor to reduce his or her risk (which is measured in part by the volatility of a portfolio of assets) up to a certain point without reducing return. This applies both to diversification among asset classes and to diversification within asset classes. Active investors such as KCS do tend overweight or underweight certain asset classes, sectors or countries based on our future risk and return expectations, but that doesn’t mean putting all your eggs in one basket.
For example, within the equity (stock) portion of your portfolio (which could be nearly 100% for a young, aggressive investor), you can choose from 10 major sectors (and sub-sectors within each sector) and dozens of countries. Unless you are clairvoyant (and no one is) you should never buy only technology stocks or only American stocks. The same goes for the fixed income portion of your portfolio (which could be very high for a conservative investor), as there are a number of sub-classes within fixed income—investment-grade corporate (US/foreign), municipal, high-yield, convertible, mortgage-backed, etc.—and it almost never makes sense to invest in just one of these.
Chasing performance is not an advisable long-term strategy either. Companies, funds and other investable entities tend to revert to the mean (average) over long periods of time—so all things being equal you should expect outperformers to become underperformers in the future and vice versa. While occasionally a fund has a great manager or a company has excellent management that does unusually well for an extended period of time, there has never been a single fund, company or asset class that has always outperformed the competition.
Chasing performance can get you into deep trouble. Say you decide to throw in the towel on diversification and invest only in US stocks. Chances are, it won’t be long (perhaps as early as next year) before international stocks start to outperform our own. For example, in 2006, international equities returned +26.3%, while the S&P 500 was up only +14.8%, trailing overseas markets by -11.5%. Investors do this all the time: jumping into a hot asset class just as it’s about to lag (or even tank). Remember 2000? That’s when everybody piled into the NASDAQ, just a few short months before it plummeted -80%. Don’t follow the lemmings: create a diversified portfolio and rebalance periodically to keep it that way.
There are tables showing how different asset classes performed in each year, and they make the argument for diversification by showing how the winners change over time in an unpredictable fashion (we can send you one if you wish). Diversification helps keep you from making the wrong decision on where to invest, and helps ensure that your investments never dramatically underperform. You may miss a huge win, such as by investing a large portion of your portfolio into a stellar performer like Google, but you’ll also avoid decimating your nest egg by doing the same thing with a company like Blackberry.
Concluding our Consumer Discretionary Series
As some of you may recall, we have been extra-bullish on consumer discretionary stocks for over a year now. We devoted the second part of our November 2012 KCS eNewsletter (scroll down to the section entitled “Hey American consumer, you can afford to live a little now”) to a discussion about consumer discretionary stocks and why we thought they would outperform other sectors over the next year or so. We followed that up with an August 7, 2013 blog that monitored the sector’s performance, and showed that the global consumer discretionary ETF was the top-performer of all sector ETFs (from 11/16/2012 – 8/7/2013). We again promised to revisit the consumer discretionary stocks in late 2013 to update their status and to hold ourselves accountable in case consumer discretionary stocks took a hit.
We are pleased to report that as of today (December 23), the iShares S&P Global Consumer Discretionary Sector ETF remains the top performing sector since we first wrote about them on November 16, 2012. We believe this is at least partially due to the thesis we laid out in the original KCS eNewsletter. We opined that since Americans were spending a record-low percentage of their salary on food, energy and financial obligations, more income would be put towards discretionary items that people had been holding off purchasing for so long. Did we also need some luck on our side? Sure. Another recession (which we still believe to be a few years off) would have hit the consumer discretionary sector hard and caused their stocks to tank.
A proper investment prediction (which we make only rarely) requires both a start date and an end date. People tried to take credit for “predicting” the 2008 market rout if they wrote a bearish article in 2003 or even earlier, even though the market climbed for years prior to the eventual collapse. It’s a lot easier to predict a market decline “at some point in the future” than to predict that the S&P 500 will fall 10-15% within the next 3 months. In fact, I can promise you that at some point in the next decade or so, stocks will decline in excess of 30%. But when that will happen, and how much they will climb before and after, is anyone’s guess.
That said, we are officially scaling back our extra-bullish feelings on the consumer discretionary sector. While we’re not yet ready to underweight consumer discretionary stocks in our portfolios, we do expect some reversion to the mean as we discussed above. In 2014, it’s likely that one of the other sectors will be the top performer. In part because we haven’t yet completed our investment plans for 2014, we’re not making any predictions here as to which one that will be.
Thank you to all of our loyal readers for your support; we hope you find these newsletters to be helpful and informative. Please let us know if you have any questions, comments or anything else you’d like to share with us.
Happy holidays and happy New Year!
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Director of Business Development – Kenfield Capital Strategies (KCS)
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