Pitcairn Update, February 2016
By Rick Pitcairn, CFA®, Chief Investment Officer
Click here to download the printable pdf version.

Making decisions that will affect your future wealth is daunting under the best circumstances. And these days can hardly be described as the best of times. Economies are in transition, US interest rates have begun to rise, the world’s preeminent growth economy (China) is slowing and, not surprisingly, stock prices are more volatile than they have been in quite some time.

When times are tough, people often second guess their investment plans. They doubt their better judgment and look for assurance or something more troubling – quick fixes. It’s normal to look for reassurance and the most useful advice we can offer is to resist any impulse to change a long-term investment plan in response to short-term conditions.

Time & Trust Go Hand-in-Hand

Equities have certainly not behaved as we would like so far in 2016. So it’s no surprise the volatile behavior has shaken investor confidence. Some are asking, Can we still trust equities to deliver the returns needed to reach long-term goals? To our mind, the answer is clear. Equities offer the best opportunity for long-term wealth building. How much can we trust equities? The answer has as much do with time as with equities themselves.

At Pitcairn, we often talk about the difference between judging investments by quarterly or yearly results (what most of the world does) and measuring progress toward a goal using a time frame in tune with the wealth generating cycles of equity markets (what Pitcairn recommends). Knowing the typical length of investment cycles is helpful, but that’s not always enough because people’s patience is almost always much shorter than those cycles. Recognizing how impatience or fear can lead us into behavioral traps is central to Pitcairn’s investment philosophy. Helping families avoid such traps is an important value we bring to our clients and is instrumental in the ultimate achievement of their goals.

Periods of market uncertainty, such as what we are currently experiencing are unsettling, but it’s important to realize they are quite normal. Actually, market volatility in December and the first two weeks of January was far more normal than the calm we enjoyed between 2009 and 2014. We have just grown used to a reduced level of volatility and now must readjust to a more normal pattern. The long-term historical average for the CBOE VIX Index, a measure of volatility in US equity markets, is approximately 20%. Since 2012, however, the VIX index has hovered in the low to mid-teens.

Equities in the Long Run

Why should we trust equity markets even when they unsettle us? Historical data shows that the long run return from the equity asset class, from 1925 to today, averages about 10% per year (before inflation). No other asset class has a return that high over such a long period.

Equities having risen sharply during the almost seven years since the start of the current bull market in March 2009. Given those substantial gains, along with the current uncertainty of a rising interest rate environment and a slowing global economy, equity performance in the short run may be volatile. However, over the long term, our projection for equity returns is about 8%, slightly more conservative than the long-term average.

For most people, the essential question is, What can I reasonably expect my equity portfolio to return and how might changing conditions affect that performance? For example, if the US economy and global capitalism surprise us positively (like they did in the 1980s), we would expect low double-digit returns from US equities. If those same forces disappoint us, we would expect US equities to return somewhere in the range of 6%-7%. The important thing to realize is that in either case, on an absolute basis, the expected return for equities is likely to be superior to what we can expect from other asset classes.
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Keeping the Faith through Difficult Times

Unfortunately, neither their historical track record, nor our forecast for equity returns preclude stocks from experiencing scary gyrations and delivering weak returns in the short run. Fortunately, the potential impact of poor performing markets – even markets as extreme as 2008 or 1987 – are included in every financial plan at Pitcairn. History makes it clear that markets such as these will occur periodically and we set return targets inclusive, not exclusive, of such weak periods. Every plan we craft for our clients, includes a diverse mix of assets that is proven to better withstand and recover from these periods of extreme market volatility.

Following the upheaval of the 2008 financial crisis, we have witnessed dramatic changes in the global economy and many regions face significant geopolitical challenges. Some might conclude the world has been upended to such a degree that the history of the markets and of global capitalism is irrelevant to future expectations. They envision the world at an inflection point that will forever change the relationship between capital and labor, rendering negative returns to capital providers from this point on. We don’t believe this is true at all, but respectfully suggest that if it were, the problems would be much bigger than whether we should invest in equities and which wealth manager we should choose.

At Pitcairn, we believe the progress of global capitalism is, in fact, even more assured now than it was in the past when vast segments of the world’s population did not participate in it. We are confident that over the next decade or two, the tremendous power of consumers, especially outside the US and particularly in China, will be harnessed in a way that is positive for capitalism, the global economy, and global stocks.

Though the short-term pendulum may swing back and forth, we are resolute in our belief that a diverse portfolio comprised of equities and the various asset classes that created and sustained wealth in the past, will continue to do so in the future.

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