Yesterday, the S&P 500 marked the 3,454th day since its last 20% downturn. This bull market has officially become the longest on record since the end of World War II, more than tripling in value since it started in March of 2009. Add in dividends, and it has quintupled in that period!
So far this year, the S&P 500 is up 6.86% through yesterday.
What’s that?
Your portfolio isn’t up that much?
Well, you’re not alone. If you own a diversified portfolio of bonds and stocks that includes investments other than US Blue Chips, aka S&P 500 stocks, you probably are trailing the US benchmark index in 2018. Bonds, REITs, commodities, and foreign stocks have been detractors from performance for diversified portfolios this year. But the less economically developed countries, known as emerging markets, have been the biggest losers, to date.
A few years ago, you may recall that our fears seemed to center on PIGS (Portugal, Italy, Greece, Spain). Today, our attention has turned to Turkey (and Argentina, Russia, etc.). The US Federal Reserve and other central banks created an opportunity through bond buying programs known as Quantitative Easing (QE) in the years following the 2008 crisis for markets like Turkey to borrow huge sums of money at relatively low costs.
These borrowings fueled economic expansion. But the US has reduced the QE bond buying while also raising short term interest rates to temper growth here. Those factors have made the US dollar more attractive as interest rates rise here in the States. With many of the bonds and loans taken out in emerging markets, like Turkey, denominated in US dollars, it has become harder to make payments with the local currencies, such as the lira.
Recently imposed sanctions by our government have turned the headwinds created by a rising dollar into a storm for Turkey. The dispute is over a US citizen being imprisoned following a 2016 coup d'état attempt against their democratically elected president, Recep Tayyip Erdoğan. The sanctions have had a dramatic negative effect on Turkey’s stocks and bonds, which has spilled over into other debt laden emerging markets as fears of a spreading debt crisis have increased.
All of those recent happenings clearly demonstrate some of the types of additional risks that emerging markets can entail. This is also an example of why emerging markets are worth investing in.
Returns come from taking risks. The higher the risks, the higher the expected returns are from those investments. It’s a similar story when we compare the stock market to the bond market or small companies to large companies. We invest in assets that we expect higher returns from because they are riskier. Otherwise, if we weren’t rewarded for potentially losing, we would leave all of our money in risk free assets such as FDIC insured checking accounts.
We manage risk by making conscious choices about how much is appropriate for each individual’s personal tolerances and goals. Then, we diversify among a broad range of those categories, such as country, stock size, valuation, and profitability. The upside is that some of those categories move up when others are moving down, which can smooth the ride for investors.
In our most aggressive portfolios, there may be as much as 15% allocated to emerging markets. While that may be more than a neutral weighting such as may be found in the MSCI All Country World Index, Turkey still represents less than 1% of the overall model. For the vast majority of clients, those allocations are even lower.
A diversified portfolio won’t always behave like a less diversified one. If it has investments that don’t correlate to the ones that we may be most familiar (i.e. S&P 500, Dow Jones Industrial Average, etc), there can and will be periods that returns will diverge. Sometimes that will be a positive divergence, and sometimes it will be negative.
The recent period of volatility in emerging markets has done nothing to change our approach. In fact, it serves as a reminder of why we don’t allocate all our models into the investments with the highest expected returns, because volatility is the inseparable dance partner. We will continue our strategy of tailoring the risk in all our clients’ portfolios to your unique situations and attitudes towards risk, with thoughtful allocation to those areas with higher expected returns.
Even if one occasionally is a Turkey.
If you would like to discuss PIGS, Turkey, or other menu items in your portfolio, get in touch.