Client Question of the Week:
Should I be concerned about the recent underperformance of small and value companies?
When you go through a time period like we have gone through recently where value has underperformed growth, and small caps have underperformed large caps, it's natural for people to want to question if they should change their asset allocation. However, getting past the recency bias and understanding that we want to make investment decisions based on probabilities rather than possibilities may lead to a better investment experience.
Taking a step back, we know that both the value and size premiums are rooted in sound economic theory. All else being equal, companies with lower relative prices (value stocks) and lower market capitalization (small cap stocks) should have higher expected returns. In addition to being economically sensible, these premiums are supported by a preponderance of evidence spanning nearly a century in the US and more than five decades in non-US markets.
While we wake up every day and expect positive value and size premiums, we understand there is volatility associated with pursuing these premiums. Exhibit 1 shows the percentage of 1-, 5-, 10-, 15-, and 20-Year periods with negative premiums in the US equity markets through December 31, 2019. As illustrated below, there will be times when we experience negative premiums, but as an investor, you need to determine if you want to make a decision that has a high probability or low probability of success.
Emerging markets are an important part of a well-diversified global equity portfolio. However, recent history reminds us that they can be volatile and can perform differently than developed markets. In this article, we provide a longer historical perspective on the performance of emerging markets and the countries that constitute them. We also describe the emerging markets opportunity set and how it has evolved in recent years.
RECENT PERFORMANCE IN PERSPECTIVE
In recent years, the returns of emerging markets have lagged behind those of developed markets. As shown in Exhibit 1, over the past 10 years (2010–2019) the MSCI Emerging Markets Index (net div.) had an annualized compound return of 3.7%, compared to 5.3% for the MSCI World ex USA Index (net div.) and 13.6% for the S&P 500 Index. While recent returns have been disappointing, it is not uncommon to see extended periods when emerging markets perform differently than developed markets. For example, just looking back to the prior decade (2000–2009), emerging markets strongly outperformed developed markets, with the MSCI Emerging Markets Index (net div.) posting an annualized compound return of 9.8%, compared to 1.6% for the MSCI World ex USA Index and –0.95% for the S&P 500 Index.
Market Returns and Election Years
On November 3rd, millions of Americans will cast their vote for the next President of the United States. Although the outcome of the election is uncertain, one thing we can count on is that plenty of opinions and prognostications will be floated in the months leading up to Election Day. In financial circles, this will almost assuredly include perceptions and opinions of market impacts. But, should long-term investors focus on presidential elections?
It is natural to draw a connection between the administration in power and the influence they may have on markets. However, we would caution investors against making short-term changes to a long-term plan to try to profit (or avoid losses) from changes in the political landscape. The 2016 presidential election serves as a recent example of the risks associated with trying to forecast market movement based on election results. There were a variety of opinions about how the election would impact markets, but many articles at the time posited that stocks would fall if Trump were elected. One article went as far to say, "Wall Street is set up for a major crash if Donald Trump shocks the world on Election Day and wins the White House." Yet, despite President Trump being in office, along with ever-present uncertainty arising from a host of events including the Brexit vote, negative interest rates, trade wars, and geopolitical turmoil in the Middle East, to name a few, the markets reached all-time highs prior to COVID-19.