It’s often said that investors are their own worst enemies. One reason this seems to be true is because they tend to have very short memories. It wasn’t all that long ago I was getting questioning calls from nervous investors asking why they had such a heavy allocation to U.S. stocks, typically about 60 percent.
When the financial crisis first hit the United States in 2008, Europe was perceived mostly as an innocent bystander to the financial carnage. As a result, it became seen as a likely safe haven.
Over the five years prior to the crisis, 2003 through 2007, the S&P 500 Index returned 12.8 percent per year while the MSCI EAFE Index returned 22.1 percent and the MSCI Emerging Markets Index returned 37.5 percent. In other words, the MSCI EAFE and Emerging Markets indices outperformed by 9.3 percentage points and 24.7 percentage points, respectively.
Looking at total returns presents an even more dramatic picture. Over this period, the S&P 500 returned 82.9 percent, the MSCI EAFE returned 171.2 percent and the MSCI Emerging Markets returned 390.8 percent.
Given the dramatic differences in returns, it was very difficult as an advisor to keep investors disciplined. My message was simply that these types of divergences in returns are to be expected, although they happen in unexpected ways, and we diversify across the globe because we don’t have clear crystal balls to tell us which countries will perform the best, and neither does anyone else.
I would explain that there would almost certainly be periods when U.S. stocks underperform, and just as certainly there will be periods when they outperform.
The Virtue Of Discipline
The key to being a successful investor isn’t about being able to forecast which markets do well when, despite what Wall Street and much of the financial media would like you to believe.
Instead, it’s about remaining disciplined and firmly adhering to your asset allocation plan. And that means having the courage to rebalance back to your target allocations, which can involve buying assets that have done poorly and selling assets that have done well.
Most investors are not able to do this on their own. In fact, the evidence clearly shows investors, as a whole, are performance chasers, selling what has done poorly (at relatively low prices) and buying what has done well (at relatively high prices). And that’s not exactly a prescription for investment success.
Compounding the problem caused by five years (2003-2007) of dramatic underperformance on the part of U.S. stocks were concerns raised by the financial media about the likelihood, if not certainty, that, as a result of the financial crisis, the U.S. dollar would lose its status as the world’s reserve currency. That only served to heighten concerns about the outlook for U.S. equities.
In case your memory is short (no one is talking any longer about the dollar losing its status, to be replaced by the euro or even the Chinese yuan), here are some examples of the headlines from just a few years ago:
- In June 2010, the United Nations released a report that called for abandoning the U.S. dollar as the main global reserve currency, arguing it had been unable to safeguard value. The report received support not only from Russia and China, but also from Nobel Prize-winning U.S. economist Joseph Stiglitz.
- In November 2010, China and Russia announced they would renounce the U.S. dollar and resort to using their own currencies for bilateral trade. In the same month, China announced plans to boost cross-border yuan-denominated trade with other countries to 20 percent of total trade, a tenfold increase, to reduce reliance on a few reserve currencies.
- In February 2011, the International Monetary Fund issued a report on a possible replacement for the dollar as the world's reserve currency, saying that special drawing rights could help stabilize the global financial system.
