Casual observers of financial markets are these days likely to have formed a fairly clear view of things. Common perceptions are that stocks have never been as volatile and dangerous; that the good times are behind us and we should all learn to live with much lower returns in our portfolios; and that physical gold is the only thing we can really call a safe investment anymore. What’s striking about the accepted truths of our time is that they are, for the most part, unsubstantiated by the facts.
One of the best performing asset classes of 2012 was Greek government bonds. Think about that, in the context of everything you read throughout the year.
The period after the global financial crisis of 2007-2008 has been unshakably thought of as a “new normal” environment of lower expected returns on risky assets. In reality, it’s been one of the strongest periods of equity performance in many market participants’ entire careers. By February 2012, the S&P 500 had a trailing three-year cumulative return of 97.9%, albeit as a result of bouncing back after the crushing losses from the crisis. In the last 40 years, the only times we’ve seen comparable gains were the go-go days of the mid ‘80s and the nosebleed-inducing highs of the dotcom bubble of the late ‘90s. Any investor that shunned equities in 2009 because of their “new normal” lower return expectations did so to very harmful effect. The sentiment is reminiscent of a Businessweek cover story “The Death of Equities” famously published in 1979, shortly before a 20-year bull market in stocks.
This is also an environment characterised in the media, as well as everyday discourse, as a time of extreme volatility for securities prices. Our heads spin at talk of risk on/risk off, high frequency trading, flash crashes, and so on. And capital has flown into minimum variance and low beta products for some cover from the market’s whip-sawing ways. But against this backdrop, the VIX Index, widely used as a barometer for equity volatility, has been testing multi-year lows. After sailing north of 80 in late 2008, the VIX fell to just 12.5 in mid-January 2013, a level it hadn’t reached since January 2007. This nose-dive has been a bit of a set-back for volatility-linked exchange-traded products (ETPs) such as the iPath S&P 500 VIX Short-Term Fut ETN (VXIS), which launched in late 2009 to capitalise on the pervasive sentiment of fear in the market and which has lost more than 96% of its value since then.
Searching for a Gold Standard
With many of the erstwhile stalwart sovereign bond issuers in trouble, investors have turned to physical gold as the, well, gold standard of safe investments. But how are we measuring ‘safe’? The monthly returns from an investment in the spot price of gold have exhibited annualised volatility of 18.9% in the last 10 years, a higher standard deviation than the corresponding results of the MSCI World index, which measures the performance of global equities. Of course the total gains of the former have soundly trounced the latter, but the fluctuations are instructive in reminding us that no matter what special properties we ascribe to the precious metal, its price can as easily go down as well as up. Surely we should pause before declaring something the safest part of our portfolio when it has been more volatile than equities over a 10-year period.
Another broad assumption relates to the superior skills and access of those in the know. In the asset management business, hedge fund managers are considered the “smart money,” and that perception is certainly reinforced by the fees they charge. Odd, then, that this “smart money”—as measured by the Morningstar Broad Hedge Fund Index—has underperformed the S&P 500 in 7 of the last 10 calendar years. In truth, there’s nothing magical about the way the average hedge fund manager invests, and retail investors that are careful about costs, stay disciplined, and focus on the very long term stand every chance of doing just as well.
Wide Disparity Between Perception and Reality
These examples illustrate the vast gulf that has developed between the general mood surrounding the markets, and the reality of how they have been faring. One of the best performing asset classes of 2012 was Greek government bonds. Think about that, in the context of everything you read throughout the year.
Global financial markets have become exceedingly complex. It’s very easy and comforting for us to cling to simple and intuitive story lines, and to listen to pundits bearing sound bites. But a vital element of successfully managing our financial lives is the ability to cut through much of the conventional wisdom and stay focused on our long-term goals without letting the drama of our immediate circumstances knock us off course. When “everybody knows” that something is the case, you can usually bank on the opposite being true.
