Bob French, CFA

How Does the Market in 2018 Stack Up Historically

There’s been a lot of sturm und drang around what the markets have been doing lately. The financial media has been talking about how this is the sign of the inevitable end of the world 

Of course, we’ve had a few things lately that were also supposed to be signs the world crashing down on our ears.

But, well, the world is still here. 

What all of this really boils down to is that the financial media is not your friend. Please don’t mistake this to mean we are screaming ‘fake news;’ but it is important to realize that media outlets are there to sell your attention to advertisers. When it comes to finance, the easiest way to get your attention is to talk about how you are going to lose a lot of money – either because you’re going to miss out on a great market (unless you do what they tell you to do), or the market is about to crash (and here’s how to protect yourself). Again, financial reporters aren’t bad people out to get you. It’s just that their job is to get your attention. I’m sure the vast majority of them want to help you have a better investment experience, but that’s just not where their incentives lie. 

This leads to them turning whatever is currently happening in the market into the biggest event since the Great Depression, and because that’s all anyone hears, it makes sense that everyone gets incredibly worried about what the markets are doing. For my part, I think it’s worth taking a look at the data, and seeing what the market has been up to recently, and how that fits into the broad sweep of the market’s history. 

First off, 2018 has not been a fun year for the markets. Through December 17, the S&P 500 Index is down a little more than 5.1% on the year. No one likes losing 5% of their money, but it’s definitely something we should expect every once in a while. Cliff Asness, who heads up the fund family AQR, breaks down the numbers well. He points out that this 5.1% drop is actually in the 24th percentile for comparable periods of the S&P 500 Index since 1928. So, not a good year, but based on what’s happened in the past, we should expect this about once every four years. It’s just that the markets have spoiled us for the last decade. 

It can be tough to remember that we earn our returns by accepting risk, but this is what risk looks like – this is where we earn the longterm returns we are looking to harvest. 

Speaking of risk, the year to date annualized daily volatility of the S&P 500 Index (again through December 17th, and courtesy of Cliff Asness) was 16.5%. Since 1928, this puts this year in the 66th percentile for volatility. In other words, this year is a little more volatile than average, but it’s also firmly within the range of normal (and remember last summer when everyone was worried that that market’s volatility was too low?). 

So, if the markets have been firmly in the “not good, but pretty typical” range, why the collective freakout that we have been seeing?  

Well, part of it is simply that the media would freakout about whatever was happening (again, the media was making everyone worry about how volatility was too low last summer). It’s also because the markets have been doing so well for so long. We’ve come to expect good (or at least positive) returns, but in the back of our minds, we know that the party has to come to an end, and we don’t want to be the suckers who have to clean up the mess.  

However, the markets will turn around. That’s one of the few definitive statements that we can actually make about the markets. The problem is, we don’t have any way to predict when that turnaround will actually happen. We have all the data that we could ask for to show that we simply can’t predict what the markets will do next, and trying to do so usually doesn’t turn out so well (especially when we’re looking at short term data). 

So what does this mean that you should do? Well, it means that you should do what you would be doing anyways. Not all that much (though it being the end of the year, this might be a good time to rebalance to make sure that you’re still taking the right amount of risk in your portfolio). It’s not the sexiest answer – which might be another reason the financial media wants to hype everything  but it’s the right answer. As longterm investors, this is just par for the course. We care about harvesting the longterm returns that the market has on offer, and dealing with periods of bad returns is just part of the process. 

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