Doctrine of the Mean

When one asset class is outperforming another within a diversified portfolio, investors sometimes wonder why both are held. The recent US stock market vs. the weaker International market such an example.

The non-US stock market’s (MSCI EAFE) 3-year annualized return was not far off long-term stock averages, but the US market’s (S&P 500) unusually high 3-year return of 17.9% made well-balanced investors envious of less diversified portfolios. During the financial crisis a few years ago, many investors wished they had no stock holdings at all.

In his “Doctrine of the Mean,” Aristotle advised “moderation in all things.” In the short run, the extremes can be more (or less!) appealing. In investing, as in life, moderation pays in the long-run. Wise investors know this and maintain diversification across an array of asset classes, including non-US.

In our 1st Quarter 2009 blog post, at the bottom of the global financial crisis market, we commented on a chart showing that markets are cyclical and that investors shouldn’t abandon stocks. Stocks subsequently recovered. The chart below may make a similar case for international stocks, even if it takes some time. Cycles vary in length, but highs and lows eventually revert, unpredictably, and sometimes rapidly. In the long-run, discipline and diversification prove powerful.

See important disclosures here.