Putting market pullbacks and “worst” market days in perspective for rattled or complacent clients

February 27, 2018 Categories: Portfolio Corner
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Investors are being hit with an endless string of print and TV headlines about the recent U.S. stock market volatility. Many of these stories are about the “worst day” or “worst 3 days” in the HISTORY of U.S. stocks. But we know that volatility in equity markets is nothing new. In fact, equity volatility is one of the reasons stocks typically provide higher long-term market returns than historically less volatile asset classes.

A little perspective can help ease investor concerns. For instance, consider the following facts:

  • The 14 consecutive months of positive returns U.S. stocks (S&P 500® Index) had experienced by January 31, 2018 likely created an unhealthy complacency for many investors.
  • As of December 31, 2017, the average calendar-year stock market (S&P 500 Index) pullback since 1995 has been -14.3%. We haven’t experienced a pullback of that magnitude since 2011.
  • The recent market volatility was not “the worst ever” when measured by returns (instead of by index points). To imply it was “the worst ever” is akin to financial malpractice.

Let’s dig a little deeper into each point.

An unusually long streak of consecutive positive monthly U.S. stock market returns

Monthly U.S. stock market returns (%):

U.S. stocks: S&P 500 Index. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

U.S. stocks haven’t experienced a calendar year with 100% positive monthly performance since 1926—when Calvin Coolidge was President of the United States. While month after month of positive stock returns make for a pleasant investing experience, this pattern risks lulling many investors into forgetting that pullbacks are normal.

Pullbacks are normal and don’t portend a bad year for stocks

U.S. Equity: S&P 500® Index.
Source: Morningstar. Returns calculated with dividends included. Maximum peak-to-trough represents the return difference between the largest peak-to-trough of the calendar year. Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

Market volatility is not uncommon. Consider the following observations regarding the exhibit above:

  • In 19 of the last 23 calendar years, U.S. equity markets finished in positive territory
  • The average annual pullback (peak-to-trough) in the last 23 calendar years was -14.3%
  • In 10 of the 14 years where the pullback exceeded -10%, the stock market still finished the calendar-year in positive territory

This year’s January through Feb. 16th pullback of -10% might have felt unsettling for investors who had grown accustomed to calmer markets. After all, the worst peak-to-trough pullback in 2017 was -3%. Such a minor pullback hasn’t been seen since 1995. However, the choppy start to 2018 does not automatically spell doom for how U.S. stocks may finish the calendar year in 10.5 months’ time.

The recent volatility does not represent the “worst” period for U.S stocks

Many recent headlines have been sensational, with references to the down days being the “worst ever.” From an index points perspective, that is true. But from a percentage of return standpoint, it is misleading.

Consider for instance the Dow Jones Industrial Average (DJIA). This stock index is limited to 30 large cap U.S. stocks selected by a committee. In July 2010, as the DJIA crossed 10,000 points, it took about 12 months to reach the next 1,000-point milestone. At the time, a 1,000-point increase in the index represented a 10% gain.

Contrast that to more recent times: as the DJIA moved from a level of 24,000 to 25,000 points, a 1,000-point increase represented “only” a 4% gain. Of course, a 4% gain is nothing to sneeze at—but it’s a far cry from a 10% increase. As the index level rises, 1,000 points is simply not what it used to be.

1,000 DJIA points in perspective

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

On February 5th and February 8th, the DJIA fell by more than 1,000 points each. The index had never lost that many points on a single day—let alone twice in four days. However, in percentage terms, these pullbacks were nowhere near the index’s worst days ever. In fact, in percentage terms, the drops were the 26th and 33rd worst days, respectively, since 1985. Said another way, there have been 25 days in the stock market that were worse than February 5th and 32 days that were worse than February 8th. Of course, no investor is keen to see the market lose -4.6% and -4.1% in a single day, but those returns hardly represent the WORST days in the equity markets.Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

Helping clients reframe 100-point changes in the DJIA

Many investors’ perception of market volatility is anchored around 100-point changes in the DJIA—even today. Little wonder then that a 1,000-point drop caused much alarm. But you can help your clients gain perspective by reframing what a 100-point change in the DJIA means today.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

The bottom line

Help turn the recent uptick in U.S. stock market volatility into a productive—rather than intimidating—experience for your clients by reaching out to them proactively to:

Disclosures:
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly.

The S&P 500® Index is a free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. The stocks included in the S&P 500® are those of large publicly held companies that trade on either of the two largest American stock market exchanges: the New York Stock Exchange and the NASDAQ.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

The Russell logo is a trademark and service mark of Russell Investments.

Copyright © Russell Investments Group, LLC 2018. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

Russell Investments Financial Services, LLC, member FINRA (www.finra.org), part of Russell Investments.

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