As US investors, it’s important to pay attention to how the international market is behaving. The panel on the left shows that US returns were stronger from 2005 to 2019, followed by EM, Europe ex-UK and then Japan.

Now let’s look at what happened when the pandemic first hit. The middle panel highlights the role international exposure could have played in your portfolio during the initial sharp market declines in the first quarter. Japan lost significantly less than the US. Emerging Markets, even with the purple drag of having to convert their returns to US dollars, lost about the same as the United States.

As the world emerged from the deep crisis, on the right-side panel, the United States is not the only place seeing the stock market recover significantly. International markets have enjoyed a significant tailwind from a weakening US dollar. Additionally, the earnings decline on the emerging market column is actually less than the United States. There are some very interesting things happening abroad that support staying globally diversified.

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We’ve heard it time and again – “Don’t keep all your eggs in one basket.”  This childhood lesson finds its way into most investment portfolios, with diversification being an important and well-accepted principle in developing a long-term strategy with the opportunity for steady growth.

Knowing the benefits, it is all the more painful to see a situation in which diversification creates a moment-in-time significant underperformance.  So far in 2020, the single asset class of U.S. large growth companies, specifically led by technology stocks, are producing outsized returns compared to every other asset class – and by a long shot.

As an example, year-to-date returns through August 7^th for the largest 1000 U.S. companies  (Russell 1000) are +21% for growth companies and -11% for value companies.  Take a moment to think about that that difference.  Indexes of smaller U.S. companies, emerging markets, and developed countries ex U.S, were also all significantly lagging large U.S. growth companies. When we hear of the rebound of the stock market, we should remember that much of that rebound is generated by a handful of well known large technology stocks.

We have all seen the dominance of some technology stocks over the recent past and for good reason.  The value creation of technology is undeniable.  But in reviewing the returns of each of the most recent ten years, there is nothing comparable to the 2020 year-to-date outsized returns generated by large growth companies vs. every other asset class of stocks.

This brings us to a few observations:

• We are in a unique moment. The global pandemic has dramatically dampened the earnings and the returns of most industries around the world. Technology companies have so far been less susceptible to the negative earnings disruptions caused by the virus.
• We cannot predict which asset class will produce the best returns in any year. One look at the relative ranking of various asset classes, year to year for a 20 year period, tells us clearly that there has been no consistency or pattern to which asset class was the outperformer in any year.  That includes the past 5 years in which the technology stocks have become increasingly popular.  The chart at the top of this post supports this point.
• Every day is one day closer to a vaccine. At that point, it is reasonable to assume that businesses may accelerate their recovery and/or adjust to the world post-Covid.  Headwinds from Covid should recede, bringing the return of positive dynamics of diversification.

Diversification remains important for a successful long-term investment strategy. Don’t let this current market lead you to believe otherwise.

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I was talking with a mentor late last year, and she was telling me about this incredibly “reasonable” request from a client. He was asking for a very low risk 2% annual income from an investment that he was happy to hold for the next 15 years. I believe she said something like “I’ll take that request all day”.

This week’s chart illustrates why she felt very confident that she could deliver for this client.  She could go out the maturity ladder to around 10 years and buy US Treasury Note at the appropriate yield. She would get him a 2% annual payment with very low risk.

Had that client asked for a low risk 2% yield at the beginning of 2019, she would have had even less trouble designing a portfolio. In fact, if he had wanted to take periodic withdrawals, she could have built the portfolio with maturities that would accommodate shorter term cash flows without dipping below the 2% yield.

Even in December of 2008 when rates dropped during the Financial Crisis, she could have met his request. Short-term yield very nearly matched what it does today, but she still had options at the longer maturity dates to reach the desired 2% yield.

And then there’s today: his portfolio construction would be much more complex. No matter how far out she looks on the curve, US Treasuries are not offering a 2% annual income. To construct something now, she would be forced to ask the client to take on more risk or lower his annual income expectation to around 0.50%.

Just like my mentor, bond fund managers cannot go out and grab a low risk yield right now. At ThirtyNorth, we are staying vigilant – aware that managers may be digging into higher risk or asking us to accept lower returns. Those adjustments are likely market realities, but we want to be prepared to adjust your allocations in response.