The certainty of uncertainty: When not to jump

One year ago, I edited a note that cautioned investors about the then common wisdom that they should be overweight in emerging markets equities. Many investors believed – and continue to believe – that, since emerging markets offered high relative gross domestic product (GDP) growth, it would result in attractive returns. We argued that the correlation between economic growth and equity performance was essentially zero, especially over short time horizons.

While economic growth in emerging markets outpaced developed markets in 2011, emerging market equities were dismal. According to Bloomberg, China and India generated year-on-year real GDP growth of 9.1% and 8.5%, respectively. However, the Shanghai Index fell 20%, while Mumbai fell by more than 24% in local currency. In contrast, the US generated modest GDP growth, while its equity market in 2011 – with a total return of more than 2% – was among the strongest in the world.

This illustrates the critical need to focus on long-term investment truths when building portfolios rather than focusing on the collective noise of experts making economic and investment forecasts. Even if the experts are right about the economics, the ties to short-term investment results are tenuous at best. What is more, exhibiting patience and ‘doing nothing’ can often be the right strategy, especially in volatile markets.