Market Review – Second Quarter 2012

This report features world capital market performance and a timeline of events for the last quarter. It begins with a global overview, then features the returns of stock and bond asset classes in the US and international markets.

The report also illustrates the performance of globally diversified portfolios and features a topic of the quarter.

 Market Summary: 2nd Quarter 2012 Index Returns

Timeline of Events: A Quarter in Review

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The graph illustrates the S&P 500 Index price changes over the quarter. The return of the price-only index is generally lower than the total return of the index that also includes the dividend returns.  Source: The S&P data are provided by Standard & Poor’s Index Services Group. The events highlighted are not intended to explain market movements.

World Asset Class Return

Global equity markets retreated in the second quarter, giving up much of their gains for the year. Fiscal and economic strain in Europe continued to capture headlines, weighing especially heavy on non-US markets. Investors continued to turn to US government bonds for safety, pushing yields lower.

US Stocks: 2nd Quarter 2012 Index Returns

With all major asset classes logging negative quarterly performance, the US equity markets posted a -3.15% return for the quarter. Asset class returns ranged from -2.20% for large value stocks to -4.02% for large growth stocks.

Across the size and style spectrum, large outperformed small while value bested growth.

Ranked Returns for the Quarter (%)

Period Returns (%)

 International Developed Stocks: 2nd Quarter 2012 Index Returns

With all major asset classes logging negative quarterly performance, the US equity markets posted a -3.15% return for the quarter. Asset class returns ranged from -2.20% for large value stocks to -4.02% for large growth stocks.

Across the size and style spectrum, large outperformed small while value bested growth.

Ranked Returns for the Quarter (%)

Period Returns (%)

 Emerging Markets Stocks: 2nd Quarter 2012 Index Returns

In US dollar terms, emerging markets gained almost 15% in the quarter, a large turnaround from the negative performance of 2011 and the best quarter since the third quarter of 2010. The US dollar depreciated against the main emerging market currencies, which boosted dollar-denominated returns of emerging markets equities by approximately 3.3%. Emerging Europe, led by Turkey, one of the world’s fastest growing economies in 2011, was the top performer, while emerging Far East was the weakest region, with a quarterly return of 12.6%.

 Select Country Performance: 2nd Quarter 2012 Index Returns

Individual country market performance varied considerably in both developed and emerging markets. The difference between the best-performing developed market, Germany, and the worst-performing market, Spain, was 23.48% (20.69% vs. -2.79%). In emerging markets, the difference between the best performer (Egypt) and worst performer (Morocco) was almost 35% (39.23% vs. 4.28%).

Global Diversification: 2nd Quarter 2012 Index Report

These portfolios illustrate performance of different global stock-bond mixes. Those with larger allocations to stocks are considered riskier but also have higher expected returns over time.

Growth of Wealth: The Relationship between Risk and Return

The Cost of Caviar: Lower Expected Returns

Australia’s champion racehorse Black Caviar is unbeaten over twenty-two races. Think of her as a growth stock with four legs. With a brilliant bloodline and a huge fan base—she even has her own Facebook page—Black Caviar is turning into the most popular racehorse since the legendary Phar Lap.

The five-year-old mare prevailed in Britain’s premier racing event at Royal Ascot late last month. But unless you own part of Black Caviar, you’re unlikely to make much money from placing a bet on her fortunes. “The Wonder from Downunder,” as she is known, pays close to even odds with bookmakers.

That’s the problem with (perceived) no-risk bets. The high probability of a win means your expected return is very low.

It’s reminiscent of the equity market, where you can choose to buy highly priced growth stocks. Many investors are prepared to put a high price on these companies’ expected cash flows. In other words, they are prepared to accept a lower expected return for the perceived lower risk of owning a stock that is growing faster than the wider market. This is similar to how gamblers in aggregate are prepared to accept a much lower return than the wider field for the perceived lower risk of putting their money on Black Caviar.

So why not back the favorite all day? Well, that could be a legitimate decision for some investors, if they are prepared to accept lower expected returns for lower risk. On the other hand, there is strong academic evidence that there is a long-term premium for tilting your portfolio to lower-priced “value” stocks. You could think of these as the unknown or unfancied horses—the ones with the wider odds.

Unlike the racetrack, however, there is more than one winner on the stock market. It is just a question of how much risk you wish to take. Backing past winners means you forgo the chance of earning a bigger dividend on the outsiders.

And keep in mind that even if you put it all on the stock market equivalent of Black Caviar, there is still no guarantee you will be rewarded. Even champion racehorses eventually lose. And by concentrating your bet, you leave yourself more exposed to specific risks related to that one entity.

With long-term investment, you are better to spread your risk through diversification. Backing the entire field—or sections of the field—leaves you less prone to the risk associated with individual runners.

Ultimately, a great company or champion racehorse is one thing. A great investment is another. Black Caviar comes at a cost.