Short-Term Troubles

The monthly numbers for all the asset classes suffered red ink in September (save for cash), as our table from yesterday details. Fortunately, that’s a rare episode.

For the 10 asset classes listed in that table, the last time the representative indices all posted monthly losses was August 1998, which was the month of the Russian financial crisis that triggered a range of calamities, including the eventual collapse of the hedge fund Long Term Capital Management.

The crisis that came to a head in September 2008 makes the problems of a decade ago look shallow by comparison. Indeed, the current troubles are deeper and threaten the economy in a way that the ’98 ills never did. The main lesson today is that no asset class is immune from financial and economic crises. Nor is there any reason to think that all the major asset classes can’t suffer losses simultaneously.

The good news is that an across-the-board fall in the 10 major asset classes is abnormal. But it does happen, and a bit more often such events nearly happen. In addition to August 1998, we came close to a repeat performance of everything going down in April 2004, save for one investable high-yield bond index that stood alone in posting a slight gain. That’s a thin reed, though, and so perhaps it’s best to say that red ink prevailed everywhere three times in the past 10 years. That’s a 2.5% failure rate. It’s low, but it’s higher than zero, and so we can’t be blind to the possibility.

Clearly, strategic-minded investors should be prepared for such times, at least emotionally. But looking over longer periods further lessens the incidence of everything tumbling. Once you begin looking at 6-month trailing returns and longer, the frequency of all the major asset classes suffering negative performance drops significantly. Therein lies the benefit of broad diversification over time. But on a monthly basis, and certainly for weekly or daily periods, anything’s possible.

But let’s think about the longer periods. Why should we see more stability in a multi-asset-class portfolio over, say, 1-year periods vs. monthly returns? The fundamental reason is that over time, the risks that loom over commodities vs. bonds vs. REITs vs. equities are different. That may not matter in any one month, particularly when all hell breaks loose, as during last month. But the prospect of everything dropping month after month after month is virtually nil. That’s not to say it can’t or won’t happen. Personally, though, we don’t worry about that possibility. If all the world’s major asset classes post red ink for 12 months straight, the apocalypse is surely upon us and most of us will be preoccupied with such things as finding a loaf of bread and clean drinking water.

Assuming the world survives (which is one our little biases), we’re confident that our Global Market Portfolio Index will be higher a year from now, or at the very least unchanged from current levels. No, we can’t promise that forecast, nor any other of our guesstimates. But investing always involves a leap of faith on some level, and that’s the essence of our strategic assumption. Meanwhile, keep in mind that when we speak of multi-asset classes, we’re talking of its value over the long haul, at least three years out. As for any one month, or even a string of them, the noise risk is ominpresent, and sometimes the noise can be deafening.

Originally published on Oct 2, 2008 at The Capital Spectator and reproduced here with the author’s permission.