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July 8, 2010 Dear Client: Your statement is now posted to Your Online Access. Please call or email us if you require assistance logging in. As a security measure we urge you to compare the information in your statement with the statements you receive directly from your custodian, including account balances, withdrawals from, and deposits to your accounts. Q2 2010 Market Update
Index Returns for the Period Ending June 30, 2010
Equity markets declined sharply in Q2. Investors are trying to assimilate new economic data, including the European debt crisis, policy announcements of the G-20 meeting in June, expiration of U.S. stimulus measures and the BP disaster. In normal times it is difficult to derive meaning from new economic data. So difficult, in fact, that it is virtually impossible to "call" a recession until well after one has begun. Stock market performance predicts growth and decline before experts do. Does it make sense to try to predict market direction? Apparently most people think it does, based on the size of the "active manager" universe. Certainly lots of people think so, since the universe of active managers trying to beat the market is so much larger than those of us who believe it's impossible to consistently and profitably predict market pricing[1]. However, the data show just the opposite: that the large majority of active equity managers fail to beat their index.
*73% of International Small Cap managers beat the index according to these results, but before reading too much into this, consider that many if not most active international small-cap managers invest in emerging markets equities. The return of emerging markets equities during this period was 54% vs. 15% for international small-cap. We suspect that active international managers are using the wrong index, and not beating the relevant index. Active bond fund managers fared even worse. For the same period, 100% of active managers of California municipal bonds failed to beat the index. The best group of managers was the Government Intermediate-Term Bond managers: only 71% of that group failed to beat the index. Recent Market Volatility The US stock market has taken investors on a bumpy ride in recent years. This volatility has tested investor discipline and prompted some people to question their commitment to equities. While no one knows the future, looking at the past may help you gain a better view of long-term market performance and put the recent market volatility in perspective. The chart below shows the historical distribution of US market returns since 1926. The performance years are stacked in ascending order by return range. This chart illustrates that:
(Click on chart to view large version) Stock Market Corrections Over time, the market has rewarded investors who can bear the risk of stocks and stay committed through various periods of performance. Since 1926, there have been 20 stock market corrections[2] during bull markets, which means that 20 times the market declined 10% but did not subsequently fall more than 20%. Whether the market recovers again from here and avoids a bear market remains to be seen. At the very least, the more surprising development, based on historical patterns, would have been a continued bull market rally without a 10% pause. We see in the following table that the current correction is occurring sooner, is lasting longer and is deeper than the median correction; not surprising given the larger-than-median 80% gain before the correction.
Market Timing And finally, in case you are feeling the urge to "step out" of the market, take a look at the potential cost of bad timing:
Long-Term Investment Returns We are in the process of updating the investment return and risk data used in Investment Policy Statements and Financial Plans. We compiled returns data for 12-month periods, for each month going back to 1988, for a range of investment policies. We chose 1988 because it was the inception date for an important index, the MSCI Emerging Markets Index.
The past 22 years have been unusual and volatile. Bond returns have been very high, as interest rates have declined significantly. The Fed Funds rate was 8.76% at the end of 1988, vs. 0.25% today. The U.S. stock market has lost 15% over the last ten years. Despite the abnormally high returns of bonds over the entire period, and the abysmal returns of U.S. stocks over the past decade, portfolios had an average annualized return ranging from 7.8% to 8.4%, and the worst returns were all positive, ranging from 5.4% annualized for a 100% equity portfolio to 7.5% for a 25% equity/75% bond portfolio. Federal Tax Return Changes for Registered Domestic Partners and Same-Sex Married Couples The IRS issued guidance in May in a Private Letter Ruling ("PLR") to California Registered Domestic Partners, correcting (in my opinion) their filing instructions of 2007 to 2009. Since 2007, when California required RDPs and same-sex married couples to file a joint California tax return, the IRS had instructed RDPs and same-sex marrieds to allocate income and deductions to the partner/spouse who earned them, despite the fact that under California community property law, income is deemed to have been earned equally by each partner/spouse[3], i.e., each partner/spouse earned 1/2 of the combined income, and owns 1/2 of the combined assets and liabilities, acquired during the partnership/marriage. Despite the fact that the federal government generally respects state property laws, the IRS had instructed taxpayers in Publication 555 Community Property to ignore state property law and allocate income to the actual earner. Here's the old text of the Publication: "California domestic partners. If you are a registered domestic partner in California, the rules discussed in this publication for reporting community income do not apply to you. You must report all wages, salaries, and other compensation received for your personal services on your own return. Therefore, you cannot report half the combined income that you and your domestic partner earned as a married person filing separately does in California". Those of you who attended our "Same Sex Marriage" seminar in 2008 listened to a discussion of the position taken by the federal government in this regard. My attorney colleagues collectively scratched their heads at how the IRS could take this position without the benefit of specific legislation similar to "The Defense of Marriage Act". The IRS also stated that affected taxpayers can, but are not required to, amend earlier years' returns if it would save them tax. Please contact us if you want to discuss whether it makes sense to amend your return, if you are affected by this ruling. As always, please do contact us with any questions.
Regards,
[1] Determining the size of active investments vs. passive investments is not as easy as it might seem. Here's an article with an interesting approach to determining the success of active vs. passive management. |
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