What a difference a month makes. The rosy outlook for corporate America did not fade this month. However, the equity markets both home and abroad faltered over the last five weeks as uncertainty over the sustainability of earnings growth fueled speculation that the equity bull market in the US has run its course. Continued dollar strength and geopolitical uncertainty has weighed on Emerging Markets, a trend that commenced in January of this year. And geopolitical uncertainty from London to Berlin to Rome has weighed on consumer and business optimism in Europe, sending benchmarks markedly lower over the course of the month and year.
While we do not welcome a rise in market volatility, it is a normal component of a functioning equity market. In fact, an asset class devoid of volatility over the long run should lack the potential to bear significant fruit to investors. For example, a Treasury bill that matures in 3 months has extraordinarily low-price volatility while a growth stock represents many multiples of anticipated price movement. It is for this reason that a growth stock’s anticipated long-term return profile and current price assumes a significantly higher total return than that of a Treasury Bill. I use these two examples as proverbial “book ends” for illustration purposes.
History provides a useful tutorial here as the chart below illustrates that equity markets can generate very wide return dispersions in the near term (i.e. a 2-year period) and a significantly more narrow and positive band in the long run. As we all know, a portfolio that does not incorporate your emotional risk tolerance can capture more of the negative near-term results and less of the long-term positive outcomes. We are not just providing a thesis for why equities remain an extraordinary investment over the long run but also why owning other complementary and non-correlated asset classes may lower your blood pressure and enhance your ability to remain invested.