U.S. Stocks - 1st Quarter 2012

Last year the S&P 500 – a bell-weather for American stocks – was statistically unchanged from a price perspective.  When you add in dividends, the index was up 2%.  You may be feeling a lot more bumps and bruises from the year in stocks than a flat 12-month return would indicate.  Markets had wild swings and Ron Griess of the Chart Store (Hat Tip ritholtz.com) reports that 2011 was the seventeenth most volatile year for the S&P 500 since 1928.  Perhaps not surprisingly, 2008 and 2009 were even more volatile.  All of this has presented a behavioral challenge for investors with the temptation to time the market or get off the bumpy ride.

As with anything, it is very difficult to predict volatility.  It’s best to plan, though, for more ups and downs.  Volatility seems to come in patches with 15 of the 17 most volatile years for the S&P coming between 1929 and 1939 or between 2000 and 2011.  Managing your investment behavior through allocation planning, regular rebalancing, or the advice of an investment professional is critical to help avoid paralysis or bad timing.

Returns of large US companies surged ahead of their smaller peers. While large company S&P returned 2%, the Russell 2000, a common index for small companies, was down 4%.  The Dow Jones Industrial Average, even bigger than the S&P as measured by market capitalization, returned 8%.  Still, smaller stocks have outpaced large stocks cumulatively since March 2009 (when using the same indexes).

Many have watched for large companies to outperform due to compelling valuations and diversified revenue sources.  This trend may continue with strong profit margins, cash on the books, and still interesting valuations relative to larger stocks.

Dividend-paying companies, especially those outside of the financial sector, rewarded their investors handsomely in 2011.   Dividends fulfilled their promise last year helping both the total return of companies as well as raising interest from investors for their companies themselves.

We still like dividends for reasons Angie Palacios, CFP® I explained in a recent blog post.  Dividend yields are attractive relative to interest that bonds pay across the world.  Furthermore, as more boomers retire and seek a more steady income stream (no small feat in a low-yield world), a strategy that includes dividends may remain attractive relative to their cash-hoarding peers. *Dividends are not guaranteed and must be authorized by a company’s board of directors.

International Markets - 1st Quarter 2012

International allocations are increasing portions of investment portfolios.  This isn’t a fluke.  International companies represent an increasing market cap of the world’s stock relative to the states.  Over the last 10 years, international investments almost doubled the returns of US investments (33.4% for the S&P 500 vs. 64.8% for the MSCI EAFE per JP Morgan Asset Management).  Blame for foreign investment woes were most strongly linked to a European debt debacle, Japan’s earthquake natural disaster, and concerns of slowing growth in China.

The world’s challenges are hard to ignore, especially in Europe.  Austerity is a big hurdle for economies to overcome.  Companies have been beat up along with their governments and we believe that longer term there may be compelling opportunities around the world.  The role of international investments in a diversified portfolio remains relevant today in our mind in spite of disappointing recent returns.

Please note that international investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Diversification does not assure a profit or protect against loss. Past performance does not guarantee future results. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions art hos of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investments mentioned may not be suitable for all investors.

Bonds - 1st Quarter 2012

Source: Morningstar, Inc.

It seems like bonds are defying gravity at this point.  Entering last year at near record lows for yields, fixed income, as measured by the widely recognized BarCap Aggregate Bond Index, returned 7.8% vs. virtually flat returns for large-cap stocks as measured by the S&P 500. As bond returns continued to levitate, yields deflated to new record levels.  US debt was downgraded mid-year, but markets asserted a strong vote of confidence with double-digit returns for long treasury bonds.

Where to next? Past returns are not a predictor of future performance – that’s what we’re told to say by our compliance officers and in my mind, this disclaimer could not be more apropos. With interest rates telegraphed to remain low, the Fed may delay dreaded rising rates, but the ability to replicate the returns of 2011 will be a major surprise. Diversification away from a traditional mix of government bonds may help, depending on your situation.

Diversification - 1st Quarter 2012

Our recent blog post titled “Death of Diversification?” noted that 2011 was an exceptionally poor year for diversified investment positions. You may ask what we meant by diversified. For our purposes, we were referring to asset classes that are not US stocks as measured by the S&P 500 and US bonds as measured by the BarCap Aggregate Bond indexes. 

A similar, although altogether more painful time period was 2008 where all but the most risk-averse assets were in free-fall. Past performance does not predict future returns, but history has a funny way of rhyming. In 2009, as markets determined the world was not ending, diversified portfolios were richly rewarded.

January’s returns offer a peek into the behavior of markets coming out of a period where diversification has not worked.

In the chart above we compare US Stocks & US Bonds to common diversifiers. This illustrates (on an admittedly smaller scale) another inflection point for diversification where additional asset classes contributed positively to returns similar to the time period starting in March 2009.

The jury is out as to whether this period favoring diversification will sustain itself through 2012. At some point the diversification ship will right itself and reward investors that hang on with variety’s smoothing effect.

* Large Cap Stocks – S&P 500, International Stocks – MSCI EAFE NR USD, Small Cap Stocks – Russell 2000, Commodities – Morgan Stanley Commodity-Related, US Bonds – BarCap US Aggregate, Global Bonds – BarCap Global Aggregate, High Yield Bonds – BarCap Corporate High Yield.

Benefits of Process - 1st Quarter 2012

Investors are prone to periods of underperformance regardless of strategy. The response to underperformance is an important consideration for the investor's future success. Nobel Prize winning behavioral psychologist points to process:

"Organizations are better than individuals when it comes to avoiding errors, because they naturally think more slowly and have the power to impose orderly procedures." ~ Thinking, Fast and Slow, Daniel Kahneman, 2011.

At Center for Financial Planning, we have an investment committee dedicated to upholding the very processes that hedge us as investors from common pitfalls while maintaining customized financial planning solutions for each client's unique situation. There are checks and balances so that changes for investments don't occur willy-nilly. Parameters anticipating discussion of process change are documented within our written procedure. Please click here to read the full post at Money Centered.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.