Stock and bond markets are recovering from the spasms felt May 22 to June 24. This week we take a close look at what just happened; review a provocative article on why bond yields may drop further; and re-state the case for investing in Emerging Markets, which have not rallied at the same pace as domestic equities.
What Just Happened? Market spasms from May 22 to June 24 look pretty weird to the writer, particularly since diversification generally worked well during the past decade. This spring a host of asset classes fell all at the same. Diversification didn’t help; what’s the explanation?
The author, of the firm GMO, identifies the explanation as “valuation risk”. While risk is a multifaceted concept, “valuation risk” is associated with an unexpected change in a valuation input—this time the “discount rate” on an investment whose value is rising. The discount rate is a fundamental input used in estimating values of any asset and is linked to interest rates. The relationship is that, generally, as rates rise, prices fall. “It