October 2009 - Economic Outlook

Nearly $60 billion in redemptions flew out of US mutual funds in just a three-week period, straddling the absolute bottom on March 9. But the Golden Rule of investing is to "buy low and sell high." The obvious move last March was simply to get out of the way? But get out of the way of what? Global equity markets were already down over 50%. It is highly plausible that the markets-by definition forward looking pricing mechanisms-had already factored in the economic atrocities we were experiencing. The decision to bail out must have meant sellers didn't think a 50% discount was enough, and there was more downward pricing pressure yet to come. In times of significant and obvious problems, investing is difficult, discipline is critical and expected returns increase. According to a September 9 Federal Reserve survey, the US recession may be over, with economic activity stabilizing or improving across most of the nation. However, investors must be continually mindful of the inverse relationship between news sentiment and expected returns. More good news = lower expected returns in the future. Why? Because good news ushers in confidence and a sense of safety. And those factors drive down the cost of capital (investors’ required rates of return to incentivize investment). In February and March, virtually all economic news was bad news. The decision to flee capital markets could have easily been rationalized given the sentiment at the time. Disciplined investors who summoned the courage to stay invested (with appropriate asset allocations) throughout the year, have been rewarded handsomely. Asset classes across the board manifested this risk-return relationship—with prices up 50 to over 100% from the market bottom.