A few weeks ago we received a question from a concerned client. After reading an article about negative interest rates on many Eurozone government bonds, he wanted to know: “How worried should I be?”
But now, with German bonds rebounding from negative or near-zero rates, it highlights what we communicated. The quote below, from Reuters on May 6th, shows just how quickly and unexpectedly markets can change. Yields on German bonds are 11 times higher than they were just a few weeks prior!
Benchmark 10-year bund yields now trade at 0.55 percent, having hit a record low of 0.05 percent last month, when many investors expected them to turn negative.
This quote reflects just how difficult it is to forecast an event like this. Last month, everyone expected rates to turn negative. And now, a few short weeks later, they’ve moved quickly in the other direction.
While there are real issues that need to be solved in Europe, it’s impossible to predict how the issues will be solved, when they will be solved, and how best to profit from a specific prediction.
The world is a dangerous place
What’s more, there is always going to be something bad happening in the world; there is always going to be a reason not to invest. For example, Morgan Housel, a Wall Street Journal and Motley Fool columnist, wrote a compelling article a few years ago highlighting all the “crises” events that happened in the world since 1990. Take a look:
2011 (so far): Japan earthquake, Middle East uprising.
2010: European debt crisis; BP oil spill; flash crash.
2009: Global economy nears collapse.
2008: Oil spikes; Wall Street bailouts; Madoff scandal.
2007: Iraq war surge; beginning of financial crisis.
2006: North Korea tests nuclear weapon; Mumbai train bombings; Israel-Lebanon conflict.
2005: Hurricane Katrina; London terrorist attacks.
2004: Tsunami hits South Asia; Madrid train bombings.
2003: Iraq war; SARS panic.
2002: Post 9/11 fear; recession; WorldCom bankrupt; Bali bombings.
2001: 9/11 terrorist attacks; Afghanistan war; Enron bankrupt; Anthrax attacks.
2000: Dot-com bubble pops; presidential election snafu; USS Cole bombed.
1999: Y2K panic; NATO bombing of Yugoslavia.
1998: Russia defaults on debt; LTCM hedge fund meltdown; Clinton impeachment; Iraq bombing.
1997: Asian financial crisis.
1996: U.S. government shuts down; Olympic park bombing.
1995: U.S. government shuts down; Oklahoma City bombing; Kobe earthquake; Barings Bank collapse.
1994: Rwandan genocide; Mexican peso crisis; Northridge quake strikes Los Angeles; Orange County defaults.
1993: World Trade Center bombing.
1992: Los Angeles riots; Hurricane Andrew.
1991: Real estate downturn; Soviet Union breaks up.
1990: Persian Gulf war; oil spike; recession.
Danger creates opportunity
It’s a pretty depressing list. You could make a case, with any of these events, that it wasn’t a good time to be invested. However, from 1990 to today, U.S. stocks are up more than 9.7 percent annualized, turning $100,000 — for someone willing to stay invested and ride out the ups and downs — into more than $1 million!
Another way to look at this same concept is with the following chart. Returns can vary drastically over any given year, but over longer time horizons, things get less extreme. For example, since 1950, the worst 5-year return for a 50 percent stock / 50 percent bond portfolio was +1 percent, and over a 20-year period it was +5 percent.
Instead of trying to predict what will happen next, we tend to look at events like this as opportunities. Everyone knows Europe has issues to solve — that’s not a question. But, because everyone knows this, stock prices are lower than they otherwise would be. Take a look at the chart below: Europe is cheap compared to the rest of the world markets.
These lower valuations create opportunities to profit for someone, like an individual investor, with a longer time horizon.
The European economies and markets are going to have some bumps in the road — this won’t be the last one. However, humans and markets are resilient. Just like there are some “crises” happening every year, there will always be excuses not to invest. But, these excuses create opportunities to profit for those with a disciplined, long-term outlook.
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