Guts, Glory and Uncompensated Risk

The following column from Phoebe Venable, CapWealth Advisors President & COO, appeared in The Tennessean on January 13, 2017.

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For investors, part of starting every New Year is the assessment of the prior year. Year-end statements are arriving in our mailboxes and inboxes. Will you rip open your statement and immediately sit down to review the results? Or will you be one of the many that will set aside the statement until you can muster up the courage to look? If you fall into the latter category, you should know that the stock market performed quite well last year. So have no fear — rip open your statements and look!

A good year for U.S. stock market

The U.S. stock market rallied to record levels in 2016. The Dow Jones Industrial Average was up 13.4 percent last year, reaching an all-time high of nearly 20,000 points at the end of the year. Of course, the Dow only tracks the performance of 30 selected stocks. The S&P 500 Index is a much broader measure of stock market performance as it tracks 500 stocks. Last year the S&P 500 Index returned 9.54 percent (price index) or 11.96 percent with all dividends reinvested. Not a bad year at all for U.S. markets.

Markets abroad — not so much

Markets abroad didn’t perform as well. The Global Dow, an index of 150 blue-chip stocks from the around the world, was up 8.3 percent last year. But most of the gains were concentrated in a small number of countries, such as Russia and Brazil, which most Americans didn’t invest in. The Russian Trading System Index, which is calculated on the prices of the 50 most liquid Russian stocks, rallied 55 percent last year as global investors rushed into Russia following the election of Donald Trump under the assumption that the U.S. business relationship with Russia would improve. Russia is also a commodity-driven economy, heavily reliant on revenue from oil, and the recent surge in oil prices has stimulated Russia’s equity market. Brazil is another commodity-driven economy with exports in iron ore, oil and soybeans, all of which saw major price increases during 2016. Brazil’s equity returns soared 66 percent last year, although it’s worth noting that compares to -41 percent in 2015.

The U.S. economy is far more diverse than Russia’s or Brazil’s, which helps shield us from such drastic swings in our market fortunes. In fact, it is a very small group of countries whose markets performed above the rate of inflation. It’s an even smaller group of countries whose markets actually compensated investors for the risk they took investing in them.

Higher risk, higher returns

Investors must be paid a premium, in the form of a higher return, to compensate them for taking higher risk. It’s one of the most basic principles of investing—but with the caveat, of course, that there is no guarantee that you will actually get a higher return by accepting more risk! Where there’s guts, there must be the possibility of glory, with the understanding that there could just as well be agony. While the U.S. certainly has market ups and downs, and plenty of things to go wrong economically, we’re generally better off than the rest of the world, including Europe. On top of a historically more reliable and robust economy, we also have the most established governmental and legal institutions to safeguard investors. Some of the international or emerging markets offer great potential but they come with more fragile and unpredictable institutions and balances of power.

If you rip open your year-end statement and disappointment sets in, it may be a good time to meet with your adviser and discuss your portfolio. No matter the investment asset — be it foreign equities, alternative investments or bonds — you should be adequately compensated for the risks you’re taking over time.