|
January 17, 2005 Dear Client: 2004 was another year to make investors smile. All major asset classes had positive returns, led by foreign and small-cap stocks.
The decline of the U.S. dollar more than doubled the returns of stocks and bonds of foreign investments for U.S. investors. Foreign stocks gained 25% over the last two years in local currencies. When converted back to dollars for U.S. investors, the return was 60%. U.S. bonds returned 4%. International bonds gained 13% in dollar terms. The reason for including foreign investments in a portfolio is diversification, not an attempt to predict currency movements. The stellar returns of the foreign equity portion of your portfolio result from proper diversification. There is no reason to increase the foreign equity weight in most portfolios at this time. In fact, some clients' portfolios have become over-weighted in foreign investments and will be rebalanced back to appropriate proportions. So much has been written about the benefits that have accrued to foreign currency investors in the last three months that the "plumber theory" comes to mind. The plumber theory originated back in the late 1990s when the chief investment officer of Morgan Stanley said his plumber started talking stocks to him. The theory goes that when an investment strategy becomes so widely held, it is time to get out. Whether or not you subscribe to the plumber theory, it is worth considering that perhaps the decline of the dollar has run its course. If so, what is the appropriate investment strategy? It is probable that the rate of decline experienced in recent years will slow. The resulting changes in balances of trade and inflation would correct the currency imbalance. And interest rates are already negative in real terms, i.e., after the effects of inflation. Investors will not accept negative returns on bonds for a prolonged period. If the dollar appreciates significantly, the same tailwind experienced by Euro (€) investments becomes a headwind; i.e., reduces returns proportionately. Consider a case in which an initial investment of €10,000 gains 20% during your holding period and is then worth €12,000. If the dollar depreciates 25% relative to the Euro during your holding period, then your €12,000 equals $16,000, for an overall 60% return on your initial investment. If the dollar instead appreciated 25%, the same €12,000 would be worth $9,600, for a 4% loss.
On a separate note: several clients have thanked us for their portfolios’ performance recently but we resist the urge to take credit for that performance. The benefit of being a passive investor is that you get what is your due: market returns. But markets will have losses again for periods in the future, and so will your portfolios. By managing responsibly we hope to temper the severity and duration of future losses. Still, we are very happy to see such positive investment returns. If you have questions or comments please don't hesitate to call or email. Regards, Audrey Grubman, CFP® P.S. Please see www.grubmanfinancial.com for new information on 2005 retirement contribution limits and special considerations for tsunami relief donations.
|