Quote for the Week

One of the studies that I did for my first book, “Pioneering Portfolio Management,” looked at the behavior of endowments and foundations around the crash in October 1987… There was a huge rally in treasury bonds on October 19, 1987. So, stocks were cheaper and bonds were more expensive. Well, what do you do? You buy what’s cheap and sell what’s expensive. But what did endowments and foundations do? Well, if you look at the annual reports of their asset allocation, in June of 1987, their equity allocation was higher than it had been for fifteen years. The ’70s were a terrible time to invest in stocks, a bull market had started in 1982. We were five years into this bull market and people were getting excited about the fact that stocks were going up and equity allocations were at a fifteen-year high. Of course, the money had to come from somewhere, so bond allocations were at a fifteen-year low.

Fast forward to June 30, 1988 and stock allocations had dropped and, not only had they dropped, they dropped by more than the decline in stock prices associated with this collapse in October 19, 1987. Bond allocations had increased by more than could be explained by the increase in bond prices over the course of the year. The only conclusion that you could draw is these supposedly sophisticated institutional investors sold stocks in November and December and January because they were fearful and they bought bonds in October, November, and December — maybe because they were fearful or maybe because they were greedy. Emotion ruled the decisions, not rational economic calculus. The costs were huge — not just the immediate costs in terms of the move from stocks to bonds. It took these institutions until 1993 — a full six years — to get their bond allocation back down to where it had been prior to the crash in October 1987. And this is in the context of one of the greatest bull markets ever… For a full half-dozen years, in the midst of this bull market, colleges and universities were over-allocated to fixed income relative to where they had been in June of 1987. — David Swensen (source)

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Quote for the Week

We all know that if we follow the speculative crowd we are going to lose money in the long run. Yet, somehow or other, we find ourselves very often doing just that. It is extraordinary how frequently security analysts and the crowd are doing the same thing. In fact, I must say I can’t remember any case in which they weren’t.

It reminds me of the story you all know of the oil man who went to Heaven and asked St. Peter to let him in. St. Peter said, “Sorry, the oil men’s area here is all filled up, as you can see by looking through the gate.” The man said, “That’s too bad, but do you mind if I just say four words to them?” And St. Peter said, “Sure.” So the man shouts good and loud, “Oil discovered in hell!” Whereupon all the oil men begin trooping out of Heaven and making a beeline for the nether regions. Then St. Peter said, “That was an awfully good stunt. Now there’s plenty of room, come right in.” The oil man scratches his head and says, “I think I’ll go with the rest of the boys. There may be some truth in that rumor after all.”

I think that is the way we behave, very often, in the movements of the stock market. We know from experience that we are going to end up badly, but somehow “there may be some truth in the rumor,” so we go along with the boys. — Ben Graham (source)

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The story in the first half of 2024 was Big Tech, AI, and the market concentration in the Magnificent 7. That story changed in the third quarter. Some are calling it “the great rotation.”

You see this rotation in the returns over the last three months. What drove the S&P 500 returns, for example, from January to June was mostly flat from July to September. The Info Tech and Communication Services sectors were the best-performing market sectors by a massive margin through the first half of the year. Three months later, they no longer sit on top. The Utilities sector is the best performer year to date due to a 19.4% rally in Q3. And utilities were one of several sectors that rallied this past quarter.

That same rotation can also be seen in U.S. REITs (16.8% gain in Q3) U.S. Small caps (9.3% gain in Q3), Emerging Markets (8.9% gain in Q3), and International Markets (7.3% gain in Q3) indices. Each outperformed the S&P 500 over the last quarter.

While there is no guarantee this continues, it’s a sign of a healthy market when money seeks out cheap over expensive. It’s certainly better than a FOMO-driven market where money chases a handful of stocks simply because they went up a lot.

If anything, the past three months have been a great reminder of the benefits of diversification and why timing the market is a losing proposition. Asset classes, sectors, and global markets move in and out of favor. It’s impossible to guess when or for how long these cycles last. Continue Reading…

Quote for the Week

The popular view of diversification is not putting all your eggs in one basket. If you place all your bets on one holding, you can win big or lose big, but the possible range of outcomes is wide. If you spread your bets across a number of holdings, the odds are that you will not be wrong on all of them or right on all of them. Then the range of outcomes will be narrower.

Or will it? Suppose all those holdings you bet on move in sympathy with one another. If you had held all 50 of the “favorite fifty” in the early 1970s, your portfolio would not have been diversified at all: Those 50 stocks went merrily up together and horrifyingly down together. The 50 holdings acted like one holding.

The first lesson of Modern Portfolio Theory is that diversification has more to do with seeking assets whose prices move in different kinds of rhythms than it has to do with proliferating the number of baskets in which you carry your eggs. A few holdings with radically different types of market behavior will do more to smooth out the pattern of portfolio returns than 50 or 100 holdings that move up and down together. — Peter Bernstein (source)

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The asset class, sector, emerging, and international market quilts are up-to-date through the third quarter of 2024. A few unexpected things stand out.

Interactive versions of each table can find at these links:

• Asset Class Returns
• Sector Returns
• International Market Returns
• Emerging Market Returns

You can also download copies here or grab the images below.

The biggest benefit to visualizing returns in a table format is seeing the power of diversification over time and how difficult it is to predict the best-performing asset classes, sectors, and markets in any given year. So far this year’s been a great example.

Did anyone predict utilities would be the best-performing sector year to date? Yet it tops the list, outpacing big tech through September. Continue Reading…