Di-worse-ification?

2015 ended the year much like 2014 in the equity markets in many ways.  While the returns of major market indices were very different from 2014, the results of a globally diversified investor felt similar. Disappointing returns of globally diversified investors relative to the S&P 500 Index feel all too common place in these markets.  However, we believe that now is not the time to abandon diversification and that the last few years have been anomalies rather than a new normal.

 

The chart above focuses in on the last three years where the S&P 500 has outperformed almost all other asset classes.  However, when we look back at longer periods of time we see that this is not normally the case.  There have been many opportunities over the past 15 years to add value to investor returns through global and multi asset class allocation mandates.  While it is difficult to accurately predict that this trend will not continue into 2016 given the last few years, we do have a few points to make against it.

Following the 2008 financial crisis the US began multiple iterations of quantitative easing programs in which the Federal Reserve promoted expansionary monetary policy through the use of zero interest rate policy and government bond purchase programs.  The rest of the world did not follow suit until more recently with the Bank of Japan and European Central Bank (ECB) developing their own in early 2015. The US Federal Reserve actions prompted a currency shift that has led to a flow of assets into the US and dollar-denominated assets.  This flow propped up the higher quality and more liquid US assets (Treasuries, Large Cap US Stocks, and Real Estate).

 

 

With the recent introductions of quantitative easing programs in Europe and Japan, we feel as though the developed foreign markets may be in the early stages of a comeback.  Equity valuations overseas are more reasonable than the U.S. and we feel as though the bulk of the currency movements are behind us (see chart above).  Foreign countries are much more export oriented than the US and should be net beneficiaries of the recent currency movements as their goods have become cheaper to US consumers. Therefore, we continue to favor having an international equity allocation in our portfolios as a long term core investment.

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