Risk can be defined as the “known unknowns”. Will Congress reduce the deficit; will the Fed continue monetary stimulus; will North Korea start a fight with South Korea – these would all qualify as “known unknowns” and risks to investment portfolios.
Uncertainty can be defined as the “unknown unknowns”. These are the black swans, the fundamental changes that can’t be anticipated. Events like last week’s flooding in the Midwest; the Boston Marathon bombing or the Texas fertilizer plant explosion would all qualify as “unknown unknowns”.
Investing involves risk. Risk can be managed through asset allocation and diversification, investment selection, appropriate buy and sell disciplines, and attention to detail. Uncertainty is impossible to manage but must be considered in any prudent risk management structure.
When I think about Risk and Uncertainty – whether in managing client portfolios or in my personal life – I have a variation on the Serenity Prayer that goes like this – God, grant me the serenity to accept the things I can not anticipate, the courage to deal with the things I can and the wisdom to know the difference. I focus on managing risks. I trust uncertainty to my Higher Power and don’t waste time worrying about it.
In last month’s Outlook I talked about several risks that I was concerned about, not the least of which was that the equity markets were at all-time highs and the last time they reached this level they subsequently fell precipitously. Well the equity market proved me both right and wrong during April. The S&P500 continued to move higher until April 11th when it rolled over and fell almost 4% in a week. While I thought this was the beginning of the pullback I have been expecting (and that I think would be healthy for the market), the market quickly reversed and marched higher through the end of the month.
Despite this new, higher all-time high I remain cautious. I think the potential upside from here is not as great as the potential downside. I reflect again on the economic research of International Strategy & Investment and their Economic Diffusion Index. The chart below shows that both their U.S. and Foreign indexes have rolled over in a similar pattern to 2010 / 2011 / 2012. In those years the equity markets took steep declines shortly afterwards. ISI is indicating a concern about a “growth scare” and not a “growth problem” at this time. I concur with that assessment.
So for the near term (next 6-12 months) I remain cautious and on guard for any trend change. I will make adjustments to your portfolio accordingly.
On a longer term outlook, I recently read an excellent analysis of the potential impact of shifting global demographics – The Middle Class in the Developing World. (Dick Hokenson) Here are some of the highlights:
1. Middle-class employment in the developing world experienced rapid growth from 2001 to 2011.
2. An increase of nearly 401 million workers classified as emerging middle class with an additional increase of 186 million classified as middle class and above.
3. The International Labor Office (ILO) is projecting that the number of workers in the emerging middle class and above could grow by an additional 390 million by 2017
4. ILO concludes that “this emerging middle-class in the developing world could bring about a new driver of global growth, with stronger investment and consumption…”
5. They further conclude that “this would help foster structural change in these countries, increase global aggregate demand and potentially contribute to a more balanced and sustainable economic growth…”
This long-term trend will have a significant impact on investment assets in all asset classes – stocks, bonds, real estate, commodities and yes even cash.
A well diversified portfolio is the best way to benefit from this trend.
I hope you found this report informative. Please call me with any questions and feel free to pass it on to anyone who you believe would get something from it.
Although the information included in this report has been obtained from sources we believe to be reliable, its accuracy and completeness are not asserted. All opinions and estimates included in this report constitute the judgment of the financial advisor as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
Investing involves risk and you may incur a profit or a loss. Diversification does not ensure a profit or ensure against a loss. There is no assurance that any investment strategy will be successful. Past performance is no assurance of future res