Frankie Goes to Hollywood cautioned, “Relax, don’t do it (you should know)”. Regrettably, many investors did it, pulling over $200 billion out of equity mutual funds and exchange-traded funds from October 2018 through the first week of January 2019.
Money market assets, with a real yield of roughly 0.25% to 0.50%, grew by $209 billion in 2018, more than the previous five years combined. Investors should have perhaps known the perils of panic selling, but staying the course, for some at least, proved to be difficult.
Admittedly, I have not seen the investment policy statements of each of these investors. Presumably, some of them were simply following an investment plan that called for building liquidity or de-risking the portfolio in the fourth quarter of 2018. Others may have had the stated investment goal of generating yields that are 25 to 50 basis points above the annual inflation rate, which by the fall 2018, money market strategies provided. To those investors, I say kudos for following your investment plan.
I suspect, however, that a far larger number of investors were driven by fear. I get it. It got so bad this fall that I didn’t even want to turn on the television, listen to the radio, or open the newspaper…but admittedly the New York Giants might have had something to do with that, too.
There is an instinct, when the S&P 500 Index, Nasdaq Composite Index, and Russell 2000 Index are down 14%, 17%, and 19%, respectively in one quarter, to do something. The problem is that doing something rarely works out well. The worst days in the market are almost always followed by some of the best days in the market, and that causes fearful investors to capture the downside without recouping the losses on the rebound. The result, as the famous DALBAR study showed, is that the average investor doesn’t even keep pace with inflation.1
It’s in times of market corrections that it becomes even more important to remind ourselves what we know to be true:
- Market corrections happen every year. The median intra-year, peak-to-trough decline of the S&P 500 Index over the past four decades is 9%. It takes, on average, eight months for the market to return to its previous high. This correction was a bit worse than the median decline, but not as bad as the corrections experienced in 2010 and 2011, or 1998, for that matter.
- Market volatility tends to arise with monetary policy uncertainty. One calendar quarter ago, the U.S. Federal Reserve was signaling multiple rate hikes in 2019. The usual market pattern for a potential policy mistake followed—strong dollar, falling oil prices, high-yield bond sell-off, and an equity correction. The Fed recently appeared to back off its tightening stance. Predictably, the dollar weakened, oil prices stabilised, high-yield bond spreads tightened, and equities rallied. A few weeks doesn’t make a trend, but as we articulate in our 2019 outlook, we expect this year (and subsequent years) to be good for equity markets. Our tagline is “Five More Years!”
- The broad market rarely posts negative returns two years in a row. The only examples occur in the early 2000s, the 1970s, and during the Great Depression. Fortunately, this time there do not appear to be irrational equity valuations, hyperinflation, or severe disruption in global economic activity.
- Equities, historically, have gone up far more often than they’ve gone down. Since 1926, over any 3-year or 5-year period, stocks have posted positive returns 83.5% and 87.6% of the time, respectively. That number climbs to 94.6% for 10 years, and 99.8% of the time over any 15 years. Investors selling now are likely envisioning the market entering the type of period that occurs 12.4% to 16.5% of the time when stocks post negative intermediate-term returns.2 Anything is possible. But how likely is it when equity valuations are roughly average, bond yields are low, inflation is benign, and the Federal Reserve appears committed to, in the words of Fed Chair Jerome Powell, “patience”?
- Stocks, historically, have been a better-returning asset class than money markets or government bills. A $1,000 investment in 1926 in Treasury bills is worth $20,000 today. The same investment in large-cap stocks is worth $6.6 million. In small-cap stocks, it’s $33 million.2
So when the market experiences short-term volatility, it’s often important to resist your first impulse. Doing nothing could prove to be the smartest course of action. Or as Frankie Goes to Hollywood says, “Shoot in the right direction, make makin’ it your intention, live those dreams.”
- ^Source: Bloomberg, 12/31/18. Average asset allocation investor return is based on an analysis by DALBAR, Inc., which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior.
- a, bSource: Morningstar Direct, as of 12/31/18. For illustrative purposes only and is not intended as investment advice.