Last week we had the referendum heard round the world. Voters in the United Kingdom turned their backs on the Continent after 43 years.
Investors worldwide were fearful and fled equities in droves. In two days the Dow Jones Industrial Average fell 871 points.
And then a strange thing happened. Investors decided that perhaps the sky was not falling after all. Counting a one day run up before the vote, in just four trading days, the Dow had nearly returned to its level of the week before. By the fifth day, it was actually 100 points higher.
This is yet another lesson that investors should not react rashly to emotional events. In the short run, markets are highly unpredictable. Study after study going back a century has shown that investors are likely to hurt themselves by quickly reacting to events and trading emotionally.
The research firm Dalbar has shown that current investors receive about one-third of the return of the mutual funds they invest in because they make ill-timed moves in and out.
It feels uncomfortable to sit there and do nothing while the world is falling apart. But do it anyway. Your wallet will thank you.
Apple Goes Into Dow
This week Apple Computer becomes part of the prestigious Dow Jones Industrial Average. The Dow is made up of 30 stocks and since its creation in 1896 has become the single most widely cited indicator of stock market performance. And yet its quirky structure shows the dangers of relying on any one indicator to mark investment performance. The Dow Jones average is based on just price, not the total value of the companies. Once a stock splits, its weight in the Dow goes down even though the value stays the same. After some moves in the Dow this week Goldman Sachs will have the heaviest weight in the average because it has the highest price. Moves in the price of Goldman stock will have a disproportionate affect on the average. Often the Dow moves in sync with other major averages such as the S&P 500 but many times they have widely divergent moves. While the Dow is a good shorthand way of following the stock market, keep in mind that its only a snapshot of a small number of stocks and there are thousands of other great companies.
The U.S. stock market has been on a tear for nearly five years. It’s sometimes hard to keep that in mind when we have a terrifying dip like we did last week. But over this five year period the U.S. stock market has nearly tripled.
Most foreign stock markets haven’t fared nearly as well. A month ago, the U.S. stock market represented 52 percent of the value of all global stock markets, according to Dimensional Fund Advisors. At year end 2007, the U.S. represented 41 percent of the world stock market value. That may not sound like a big deal but it amounts to $4.7 trillion.
In practical terms, many investors are getting discouraged about international investing when the U.S. is doing so well. But over the long term, international markets have outperformed the U.S.
With only five percent of world population and 25 percent of world Gross Domestic Product, it seems unlikely that in coming decades the U.S. will dominate global stock markets to this extent.
Prudent investors should look beyond the recent past and try to envision the world economy over the long term. If they do, they’ll realize that international stocks should be part of most well diversified portfolios.