Q1 2019: Market in Perspective

Short-term market volatility can be nerve wracking. If you were made uneasy by the recent S&P 500 pullback, now would be a good time to review your portfolio.  

Having a plan in place will help shift your focus from short-term volatility to long-term rewards.  

Market corrections are never fun. The -19.8% drawdown in late 2018 was no exception. This is especially true when the year ended with the worst December performance since the Great Depression (1931).

Despite the negative volatility of last fall, 2018 also saw some good (or upside) volatility. Last summer saw a slow and steady increase of +13.5%. With the best January performance in 30 years, 2019 is starting out on solid footing, and the market is again positive over the last year.

Corrections and volatility are a healthy part of the market cycle, not something unexpected. From 1979-2018, the S&P 500 saw an average intra-year pullback of -14%.  One-third of those years saw a decline of more than -15%. 2018 may have felt like a wild ride, but in terms of drawdowns, it was a typical year. It’s when we look beyond the volatile short-term that the picture becomes clearer.

When is the best time to buy stocks?

Twenty years ago, but if you can’t do that, today works.

Above is a witty Wall Street saying, but a good one since there has never been a 20-year timeframe when the market lost money. Going all the way back to 1928 and looking at over 1,000 different rolling return periods, 100% were positive. Even from September 1929 – the peak of the Roaring 20s – to September 1949, which was the worst 20-year period in the study, the market still returned 2.1% per year. At the other end of the spectrum, the two decades ending April 2000 saw an annualized return of 18.0% per year (a $500,000 investment in April 1980 would have become $13.7 million by April 2000).

At shorter time periods, the probabilities are still in your favor. At the 10-year level, the S&P 500 has been positive 95% of the time, and a more conservative portfolio of 60% stocks and 40% bonds was positive 100% of the time. At the 5-year level, the S&P 500 has been positive 88% of the time, while a 60/40 portfolio – which is the most common objective among our clients – is positive 94% of the time.

In the long run, the market has a high probability of delivering a positive return. Investors who ignore the market’s short-term volatility have historically been rewarded.

Unfortunately, most investors haven’t ignored the short-term volatility, as shown in the table below.  

Over the past 20 years, the average investor has earned 4.8% per year on their equity investment. This is significantly below the 7.7% return of the S&P 500. On a $500,000 investment, the “Investor Behavior Penalty” of -2.9% would result in an underperformance of $927,000 over 20 years. That’s an opportunity cost of nearly $1 million dollars – twice the initial investment. The behavior penalty only gets worse as we shorten the timeframe: -3.3% at 10 years, -4.8% at 5 years, and an amazing -5.5% over 3 years.

The primary reason for the underperformance comes down to human emotions. Poor market timing – buying when prices were high, selling when they were low – is at the top of the list. So too are chasing performance, investing in fad stocks and industries, Market corrections are never fun. The -19.8% drawdown in late 2018 was no exception. This is especially true when the year ended with the worst December performance since the Great Depression (1931).

While overcoming those investing biases is easier said than done, a disciplined approach, and a disciplined money manager, can help. One of the best ways to avoid the “Behavior Penalty” is with an investing plan. Reviewing your long-term goals and cash flow needs will help you make rational decisions ahead of the next inevitable bear market. Finding the right asset allocation – one where the risks and rewards are balanced to your personal and financial tolerances – is key. We’d be happy to meet and dive deeper into what to look for at your convenience.

If you have any questions about your account(s), or if there has been a change in your financial situation or investment objectives, please feel free to contact our office to schedule a meeting.

The views expressed in this newsletter represent the opinion of Allied Investment Advisors, a Registered Investment Adviser. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment or services. The information provided herein is obtained from sources believed to be reliable, but no representation or warranty is made as to its accuracy or completeness. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results. Investments are not a deposit of or guaranteed by a bank or any bank affiliate. Please notify Allied Investment Advisors if there have been any changes to your financial situation or investment objectives or if you wish to impose or modify any reasonable restrictions on the management of your accounts through Allied Investment Advisors.