Why patient investors in the US have been rewarded

Why patient investors in the US have been rewarded

‘And you thought 2011 was tough?’ So went the headlines in December as media and market pundits, reflecting on a miserable year, saw no respite for investors in 2012. But markets have a strange way of confounding investor sentiment.

The general feeling, as expressed through the media, was that there would be more muddling through in early 2012. But this is just a reminder that good journalists make bad forecasters.

One prominent ABC journalist said at the end of 2011: ‘The conditions are in place for a panic sell-off.  It is not certain that it will happen…but the risk is now such that you must take action.  I will be significantly reducing my already reduced exposure to equities possibly to zero1’.

As an investor, if you allowed emotion to dictate your short term investment decisions and took this advice, you might be ruing it now.  Global equity markets2  have registered their best start to a calendar year in 21 years, up by just over 10% in US dollar terms as of the end of February.

Much of the leadership for the turnaround is coming from the US, an economy that many observers just two years ago were writing off in favour of the emerging powerhouse economies in Asia. The US benchmark S&P 500 Index was up 9% to the end of February. This is also its best start since 1991 and returns the index to the levels of June 2008 – before the Lehman collapse.

If we think back to late 2008, the US was the epicentre of the Global Financial Crisis (GFC).  Many investors wanted to remove any exposure to the US from their share portfolios, fearing that a ‘lost decade’ of returns was on the horizon.

Even if we had recommended this course of action to clients, implementing it in a practical sense is almost impossible.  Of the 500 largest US stocks, approximately 48% of their earnings come from non-US markets.  The impact of globalisation means it is essentially impossible to get pure exposure to many markets or economies.

Assuming an investor did remove the US from their share portfolio at the end of 2008, this is how the US sharemarket has performed relative to Australia since3:

US Stockmarket +62%

Australian stockmarket +34%

Many people would have thought you were mad in late 2008 if you had said that over the next 3 years the US stockmarket would provide returns almost double that of Australia, a country which largely avoided the sharp economic downturns experienced in the US and Europe.

So what do these results tell us? Several things:

  • There is no direct link between a country’s current economic growth and the performance of its sharemarket.

In fact, if any relationship can be observed from the evidence, it’s those countries with lower economic growth that have stronger expected sharemarket returns. 
The reason for this is markets are forward looking – just because things are bad today, doesn’t mean the market won’t start taking a view on things improving, with higher expected company earnings pushing up share prices as a result.  We wrote an article on this in October 2010 that provides more information:

Does low economic growth reduce expected investment returns?

  • You need to remain disciplined during volatile markets.  Allowing your emotions to dictate means you fall into the trap of ‘buying high and selling low’.
  • Nobody can consistently predict the future.

The US market’s strong start in 2012 followed a standout 2011, in which it was one of only three markets in the world to produce a positive return – the other two being Ireland and New Zealand.

So why the change in mood since late 2011? There are several catalysts for the turnaround in markets so far in 2012:

  • While Europe can hardly be described as being out of the woods yet, last night’s agreement by a majority of Greece’s creditors to restructure their debt will see creditors accept losses of 74% of their bonds, which will cut around 100 billion euros from Greece’s debt.  Although some details are yet to be finalised, it would appear that Greece will avoid a disorderly default on their debt.
  • There have been signs of a continuing turnaround in the US economy.
  • Central banks around the world are pumping out massive amounts of cheap cash — essentially printing money — to provide liquidity to the financial system and to support the recovery.

No–one knows how markets will perform in the short term, but investors need to understand the importance of discipline and understand the tendency for markets to absorb news very, very quickly.


1 ABC News, 19 December 2011

2 As measured by the MSCI World Index

3 Source: Returns Program from 1 January 2009 to 29 February 2012.  Returns are in local currency.  ASX 300 Accumulation Index used as a proxy for the Australian sharemarket, and S&P 500 Index as a proxy for the US sharemarket.

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Note: This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.