On July 12, The Wall Street Journal reported coffee prices were soaring due to drought in Brazil, the world’s biggest coffee producer. With the prospects of coffee demand exceeding supply, it would seem readily apparent that coffee prices will continue to climb. Or will they?
I must admit I’m not a coffee achiever. My morning intake consists solely of milk tea with ginger followed later by a raw cocoa drink with some supplements — no food. But, I’m a supporter of happy people and the prospect of low supply and higher prices for coffee makes me a little uneasy about the overall emotional well-being of the world.
But this is a good opportunity to look at markets and how prices are set. If you looked at the spot price of coffee (or gold or Bitcoin or any other commodity based on supply and demand), would you think it is undervalued, overvalued, or correctly valued? Everyone will have a different opinion, and everyone will think their opinion is correct, so who’s right? Enter an interesting illustration based on voluntary participation at a client event hosted by a financial advisor in August 2013, with the results audited by the advisor. A jar of jelly beans was set on a table; of course, we’ll call it a jar of coffee beans. The audience was asked to guess how many beans were in the jar. The highest guess was 5,365, while the lowest was 409.
This is a big range, and each person who guessed thought they were right — but no one was. Now here’s where it gets interesting. The average of all the guesses was 1,653, which was very close to the actual number of beans in the jar: 1,673. Considering this the “coffee bean market” illustrates the power of collective information and how difficult it is to beat the market.
This is actually very similar to how the stock market works and was described in Nobel Prize winning-economist Eugene Fama’s pivotal research with “The Efficient Market Hypothesis.” It essentially states that stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices — so it should be impossible to outperform the overall market through expert stock selection or market timing. Commodities are different from stocks, as in addition to supply and demand, a company’s stock price will also be affected by the estimated future cash flows of that company, something a commodity in and of itself will not give you.
Rather than get into the intricacies of stock valuation, the point is that there is a huge amount of collective data reflected in the price of each stock listed on the various stock exchanges around the world. These markets reflect the combined knowledge of all participants. In 2018, the daily average trading value was $462.8 billion.1 You may bet against the collective knowledge of the market and I sincerely hope you get lucky, but as I tell my clients, luck is not a strategy we want to count on for their financial well-being.
1 In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.
2021 Q2 Index Review Through June 30
Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. “BB=Bloomberg Barclays”. Market segment (index representation) as follows: US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index [net div.]), Emerging Markets (MSCI Emerging Markets Index [net div.]), Global Real Estate (S&P Global REIT Index [net div.]), US Bond Market (Bloomberg Barclays US Aggregate Bond Index), and Global Bond Market ex US (Bloomberg Barclays Global Aggregate ex-USD Bond Index [hedged to USD]). S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2020, all rights reserved. Bloomberg Barclays data provided by Bloomberg.
Q2 was another great quarter for stocks, and it was actually the U.S. and global REIT indexes that led the charge with 11.94% and 10.43%, respectively. As a matter of fact, all listed indexes were positive for stocks and bonds, which is a good scenario for globally allocated investors with bonds in their portfolios.
The stock market has had a very robust recovery since the pandemic and you might think it’s self-evident we might be at a high and headed for another downturn. I’m sure you will read analysis or talk to folks who will suggest a reallocation away from equities because of this. Well, they might be right and it could happen, but history suggests otherwise. The following table looks at the average annualized returns of the S&P 500 after new market highs from January 1926 to December 2018 and you’ll note robust returns one, three, and even five years out from market highs.
In U.S. dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926– December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation YearbookTM, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.
The moral of this story is to come up with a strategic allocation that fits a well- thought-out financial plan. Outguessing markets is more difficult than many investors might think. While favorable timing is theoretically possible, there isn’t much evidence it can be done reliably, even by professional investors.
The positive news is investors don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded those who have taken a long-term perspective and remained disciplined in the face of short-term noise. By focusing on the things that can be controlled (like having an appropriate asset allocation; diversification; and managing expenses, turnover, and taxes) you may be able to position yourself to make the most of what capital markets have to offer.
Morgan is an investment advisor in San Diego, Calif. He is registered with the Securities and Exchange Commission (SEC). Registration of an investment advisor does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the commission. Morgan only transacts business in states in which he is properly registered or is excluded or exempted from registration. A copy of Morgan’s current written disclosure brochure filed with the SEC, which discusses among other things, Morgan’s business practices, services, and fees, is available through the SEC’s website at www.adviserinfo.sec.gov.
Please note, the information provided in this document is for informational purposes only and investors should determine for themselves whether a particular service or product is suitable for their investment needs. Please refer to the disclosure and offering documents for further information concerning specific products or services.
Nothing provided in this document constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation or an offer to sell (or solicitation of an offer to buy) securities in the U.S. or in any other jurisdiction.
This document may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions; changing levels of competition within certain industries and markets; changes in interest rates; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of WorthPointe or any of its affiliates or principals or any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date they were made.
Other articles filed under Market Commentary
The Morgan Report Q4 2022 Review: The Year of Living Dangerously
January 11, 2023 - Danger can be defined as “something or someone that may harm you.” My role working with families as a financial advisor is to help them try to avoid dangers involved in our financial world which I believe is interestingly influenced...
The Morgan Report Q3 2022 Review: The Best Is Yet To Come
October 17, 2022 - Recently the International Monetary Fund’s (IMF) Chief Economist Pierre-Olivier Gourinchas, as a supplement to the IMF’s World Economic Outlook Report October 2022 stated in his blog that “Overall, this year’s shocks will re-open economic wounds that were only partially healed...
The Morgan Report Q2 2022 Review: Chaos – The True Norm
July 26, 2022 - Once upon a time, everything was peaceful and all beings lived in harmony. Well, I don’t know when that moment occurred or if it ever will but it sure feels like recently, random acts that are detrimental to our quality...
The Morgan Report Q1 2022 Review: Stagflation – A Perspective
April 18, 2022 - Quite often, people and investment managers select what they think are superior investments via seemingly well thought out analysis of the particular companies of interest and the macroeconomic conditions that affect them. “Obvious” picks seem to be readily apparent. The...
The Morgan Report Q4 2021 Review: The Stewards Mindset
January 20, 2022 - I’d like to submit that one of the goals in life is to evolve over time in such a manner that your perspective and insights are continually improving; some would call this wisdom. Whether this progression is in your spiritual,...
- End-of-the-Year Top 10 To-Do List
- The Morgan Report Q1 2022 Review: Stagflation – A Perspective