Stairs up, elevator down

Jeffrey Knight, CFA, Global Head of Investment Solutions and Asset Allocation | August 18, 2014

  • Major asset classes had nice gains through mid-June but have declined as of late.
  • Although we still favor equities, we think it is time to bolster portfolio resilience.
  • We are keeping our eye on Europe as the summer comes to an end.

A reputation, it is said, takes a long time to build, but a short time to destroy. One of the most frustrating aspects of investing is the tendency for gains to behave in exactly this way. Investment professionals have a saying to express this: “Investment performance takes the stairs up, and the elevator down.”

We have been noticing that this pattern has asserted itself lately in numerous areas. The chart below plots the 2014 progression of prices for the Eurostoxx 50 Index, the Goldman Sachs Commodity Spot Price Index and the iShares High Yield Corporate Bond ETF (HYG). All of these assets share the pattern of slowly establishing a nice year to date gain through mid-June, only to surrender all price appreciation by July 31. When this happens to any asset, those who are long that asset feel frustrated. When it happens across several assets — and note that this chart includes a representative from stocks, from bonds and from commodities — those who are long any asset should take notice. Not only do these assets offer a reminder of the nature of things in investing, but also reveal an emerging turbulence that may — or may not — be an early warning of volatility rising more generally.

Chart: Year to date performance of stocks, bonds and commodities

 Source: Bloomberg, July 2014

We have taken a positive view of markets this year, and have remained steadfastly bullish on equities. With year-to -date performance still comfortably positive in many areas, we think it is a good time to bolster the resilience of our overall portfolios. While our fundamental views have not changed materially, we do notice several developments that argue for mild risk reduction as summer draws to a close. Chief among these, we think, is the prominent slowdown in economic growth across Europe. Overall GDP growth across the eurozone in Q2 was 0.0, decelerating from its modest .2% trajectory during this year’s first quarter. The effects of this slowdown can readily be observed in the equity, bond and currency markets across Europe. This slowdown may pass, of course, or even prompt the European Central Bank to initiate more aggressive policy stimulus. Until we have more clarity, we are content to take down portfolio risk at this time.