(July 24, 2013) - June—or rather the May 22 through June 24 period—was an odd stretch for markets, as GMO's co-head of asset allocation Ben Inker pointed out in his latest investor note.
"The S&P 500 lost 5.6%, MSCI EAFE lost 10.1%, MSCI Emerging fell 15.3%, the Dow Jones/UBS Commodity index fell 4.5%, US 10-year treasuries fell 4.4%, and the Barclays US TIPS index fell 7.1%. For good measure, the JP Morgan Emerging Debt Global index fell 10.8%, the German 10-year Bund fell 5.2%, the UK 10-year gilt fell 3.4%, and the Australian 10-year bond fell 6.5%."
While stocks and bonds have tended to show negative correlation in the last decade, most listed asset classes seemed to fall in concert from late May into early June.
The absolute return isn't what troubled Inker, but rather the question of risk.
"For those schooled in thinking that the only 'risks' that matter for investors are growth shocks and inflation shocks, it's significantly more than just weird," Inker wrote. "To anyone of that mind, it's a bit of a soul-searching moment, and it forces you to either treat the episode as a one-off event that will hopefully not happen again anytime soon or as a challenge that requires you to rethink your risk model."
Valuation risk—the risk associated with the discount rate on an investment rising—was at the core of the recent across-the-board bear market, according to GMO. Since 2009, essentially every asset class has been bid in due low return expectations on cash. Then, Inker argued, Ben Bernanke removed that expectation by announcing a possible tapering of the Federal Reserve's quantitative easing program.
"May's shock to the real discount rate came not because inflation was unexpectedly high or because growth will be so strong as to lift earnings expectations for equities and other owners of real assets," Inker wrote, but rather because of Bernanke's signaling the end of forced low rates, or "financial repression."
"And because financial repression has pushed up the prices of assets across the board and around the world," he concluded," there is unlikely to be a safe harbor from the fallout, other than cash itself."
Read Inker's full note here.