The Past Performance Habit
We are all influenced by the “recency effect.” If an investment performed well or poorly in the recent past, our emotional reaction is to assume that trend will continue. This human tendency encourages ongoing momentum, which can impact price.
The problem is that over time, certain investment values can get distorted. For example, US growth stocks, particularly technology equities, have been world leaders. Over the past decade US growth stocks have outperformed value stocks by nearly 8% annually. Domestic stocks have exceeded international and emerging market stocks by a similar margin. Yet in the previous decade, international and emerging markets far surpassed US stocks. In fact, from 2000-2010, the overall US stock market did not grow for an entire decade, while the international markets had much higher positive returns.
In hockey, players are told to anticipate where the puck is going, not focus on where the puck is now. The same concept of looking ahead can apply in investing. Vanguard just published a current fair-value model stating, “Based on our fair-value model, we expect value to outperform growth over the next 10 year period by as much as 5% to 7% per year and perhaps by even more over the next five years.”
Historically, international and US markets have had similar long-term returns, but in the past decade US markets have substantially outperformed international. What this means is the current US growth stocks are priced higher than ever. If one assumes that some reversion to the historic mean will take place, the future upside might be in other markets that have not done as well in the past decade.
We will continue to have a diversified portfolio that includes US and international stocks and both growth and value positions. But upcoming purchases will consider potential upside for value and international and not be overweighted with recent trends.