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Stock Market’s Merry Performance Over Time

Stacking up the stock market’s annual performance going back nearly 200 years looks rather merry and bright.  Our graphic above updates the seasonal interpretation of the stock market’s history first pointed out by Carter Worth.

Each block of the Christmas tree represents the annual total return of the U.S. stock market.  The S&P 500 is used from the index’s inception in 1928 through the present.  The Dow Jones Industrial Average is used 1896 through 1927.  Finally, aggregate data published by Goetzmann, Ibbotson and Peng covers 1825 through 1895.

Since 1825, the stock market has produced an annual gain 71% of the time, or 137 times, while losing ground just 55 times. A standard distribution chart, which happens to take the shape of a Christmas tree, shows how for most years, the market moves within a range of zero to up 10%.

With only 15 trading days left in 2017, the S&P 500 is up nearly 20% year to date.  So it looks like we’ll be adding a new branch to the right side of our tree!

Happy Holidays from our family to yours.

Best Illustration of Bull & Bear Markets

Here’s the best illustration we’ve ever seen of history’s bull and bear markets.  This chart shows the performance of the S&P 500 Index from 1926 through September 2017. Blue denotes past bull markets’ durations and returns (total and annualized).  Orange denotes the bear markets.  The pink vertical bars delineate recessions.

At a 100,000-ft level, this chart underscores the benefits of investing for the long-term. Two specific takeaways:

  1. There’s a lot more blue than orange meaning stocks tend to spend more time going up in value than going down.
  2. The current bull market might feel long, but by historical standards, the length and strength of this bull is not exceptional

Source: First Trust

Chasing Past Performance is Expensive

A rigorous study from Vanguard  demonstrates that chasing the hot mutual fund is an inferior investing strategy compared to good, old-fashioned buy and hold.

Vanguard analyzed a decade of data ending December 31, 2013 across nine asset classes.  In every case the investor would have been significantly better off just sticking with the index.  On average the indexes generated 50% higher returns than the performance-chasing strategy!

Buy and hold may not be perfect, but it can be a lot better than flitting from mutual fund to mutual fund.

 

Know More, Make More

knowledge-powerA ground-breaking academic study finds that more financially knowledgeable people earn a higher return on their 401(k) retirement savings.

Dr Robert Clark (NC State University), Dr. Annamaria Lusardi (George Washington University), and Dr.  Olivia Mitchell (University of Pennsylvania) analyzed a unique dataset that combined 401(k) performance data for 20,000 employees plus financial literacy data for the same workers.

Investors deemed to be more financially knowledgeable than peers enjoyed an estimated 1.3% higher annual return in their 401(k)s or other defined contribution plans than those with less knowledge.

According to the study’s authors:
“We show that more financially knowledgeable employees are also significantly more likely to hold stocks in their 401(k) plan portfolios. They can also anticipate significantly higher expected excess returns, which over a 30-year working career could build a retirement fund 25% larger than that of their less-knowledgeable peers.”

Financially savvy people tend to save more and are more likely to invest those savings in the stock market. But past studies haven’t clearly demonstrated that these people necessarily make better investment decisions. The authors look at patterns in 401(k) retirement accounts and find that more sophisticated investors do indeed get better returns on their savings.

Source: “Financial Knowledge and 401(k) Investment Performance”

Great Expectations

Expectations are very important. If you know what to expect, you shouldn’t be surprised. And if you’re not surprised, you won’t panic.

Coaching clients on what to expect and how (not) to respond to extraneous events is our defining role as a trusted advisor. 

We invest in stocks because of their superior returns. Those historically higher returns are a reward for tolerating volatility (i.e., the “volatility premium”).  But what does stock volatility look like in the real world? What pattern of price variability should we expect?

Well, here it is in its most elegant of graphical forms (click image for a bigger view).

Here’s how to read this chart:

  • The intra-year decline versus the annual return of the S&P 500 are plotted vertically with years running horizontally from 1980 through year-to-date 2017.
  • The annual return (grey bars) show the calendar year price increase. For example, in 1980 stocks climbed 26% for the year.
  • The intra-year decline (red dots) is the largest market drop from peak to trough during that year.  For example, in 1980 we experienced a 17% drawdown.
  • Putting these together, in 1980 the stock market dipped 17% before closing up 26% by the end of the year.

It’s not hard to see that short, intra-year declines are the norm.

In fact, the average intra-year drop is 14.1%. But despite these temporary declines, the annual returns are positive in 28 of 37 years (76% of the time). During the charted time period 1980 to 2016 the average annual return was 8.5% This pattern is persistent.  If you look back to 1946, the average drawdown is a remarkably close 13.8%, and the price return was positive 50 of the 71 years (70% of the time).

History shows the declines are temporary, the advance is permanent.

Think about how the average person responds to these intra-year declines. The financial media is screaming about the crisis du jour which is consistently characterized as the end of the world (“I’ve lived through some terrible things in my life, some of which have actually happened.” — Mark Twain ).  Data shows the average investor, without the support of a caring, empathetic coach/advisor, consistently sells at the worst of times – i.e., during one of these perfectly normal and temporary pullbacks.

Volatility does not equal a financial loss unless you sell.

In our humble opinion, possessing an informed expectation, one that allows you to ignore short-term gyrations to capture long-term gains, is a Great Expectation.

“You need to judge us over a full cycle”

The standard argument that active investment managers make when challenged by their clients on why their portfolios underperformed the market is, “you need to judge us over a full cycle.”

Robust results published in today’s Wall Street Journal blow a hole through active managers’ favorite defense.  Over the 15 years that ended in December 2016, 82% of all U.S. funds trailed their respective benchmarks.  That long time period is more than enough to encompass the active managers’ “full cycle”, boom-bust-boom argument.  The findings are noteworthy because it’s the first time 15-year results have become available for this very comprehensive analysis.

The results are even worse when you looks at popular assets classes:

  • 92.2% of U.S. large-cap active funds trailed their respective benchmarks
  • 93.2% of U.S. small-cap active funds trailed their respective benchmarks
  • 95.4% of U.S. mid-cap active funds trailed their respective benchmarks

That elusive 8% of all U.S. fund managers that did beat the market 2002-2016 is a slippery target for investors.  Most of them did not persistently outperform throughout those 15 years.  So you can’t just take today’s top performers and go with them.  Said another way, the likelihood of you finding one of these funds ahead of time is very, very small.

You have a key decision — a choice that will materially impact your future life.  How will you choose to invest the bulk of your portfolio?  Will you go with the 92% odds in your favor (passive management), or the 8% odds in your favor (active management)?

Source: WSJ – Indexes Beat Stock Pickers Even Over 15 Years

Hedge Funds — Exceptional Complexity, Exceptional Underperformance

hedge-vs-sp500

The chart above compares hedge fund returns to the S&P 500 Stock Index (blue) and the Barclays/Lehman Aggregate Bond Index (red) since 2011.  Various popular hedge fund strategies are portrayed by the four colorful lines that occupy the zero-to-negative return space!  In both an absolute and a relative sense, this is stunning underperformance.  Moreover, those hedge fund returns are before fees, so the investor return is even worse. Hedge funds traditionally charge a management fee that’s 2% of assets, plus 20% on any profits.

Despite this dismal five-year run, complex and expensive hedge funds are more popular than ever.  In the Internet era, interesting, persuasive, and money-losing commentary is just a click away!

At last Saturday’s annual meeting of Berkshire Hathaway, legendary investor Warren Buffett unloaded: “There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities.”  Buffet added that hedge funds operate with “a compensation scheme that is unbelievable to me.”

Our brains are naturally attracted to “shiny objects” and our intuition suggests success requires a complex solution.  Nonetheless, empirical data such as the chart above demonstrate that wealth can be achieved through simple investments combined with simple discipline.

Happens All The Time

normal

The New Year selloff in stocks has captured a lot of attention because,

  1. We’re not used to this since the market has been unusually quiescent the past few years
  2. The decline is global
  3. The speed of descent is significant

But despite perception, double-digit declines from prior highs are the norm, not an anomaly.  It happens two out of every three years.

Here are great points of reference to put this market event into context:

  • The average intra-year decline is 16.4%. This current decline might feels worse due to the speed at which it’s happening, and because it’s occurring right out of the gate.
  • Double digit declines are to be expected, 64% of all years experienced them.
  • It’s not unusual for those double digit declines to be of little importance. 57% of the years with 10% drawdowns finished positive.
  • Stated differently, 36% of all years saw a double digit decline and still finished positive.
  • Drawdowns of 20% or more have happened 23 times, or 26% of all years. On five of those 23 occasions, stocks still ended up positive on the year.

The following chart provides a great visual on how intra-year drawdowns are normal.

intra-year-declines

Source: TII

Asset Class Performance, 1H 2015

From the Novel Investor:
The chart below shows several issues investors struggle with all the time. It’s difficult to pick the best performing investment year after year, yet for many investors it’s an annual event. They look for an encore, picking the best asset class last year with the hope of a repeat performance. Yet, betting on last year’s winner rarely works out.

Assets at the top of the chart one year could be at the bottom the next, and vice versa. Much of this is due to reversion to the mean. But over the long-term, those big swings even out. The chart shows annual returns for eight asset classes against a diversified portfolio. Diversification works to smooth out those big swings in the short-term. While you’ll never get the biggest gains of any year, you avoid the huge losses.

Asset-class-20151H

The chart above ranks the best to worst investment returns by asset class over the past 15 years.

Source: Novel Investor

Best Illustration of Bull & Bear Markets

bull-bear-chartThis is the best illustration we’ve ever seen of history’s bull and bear markets.  Blue illustrates past bull markets’ durations and returns (total and annualized).  Red illustrates the bear markets.  This was published in May 2014 so the current bull market is actually pushing 69 months.

Some key takeaways:

  1. There’s a lot more blue than red meaning stocks tend to spend more time going up in value than going down.
  2. The current bull market might feel long but by historical standards, the length and strength of this bull is not exceptional

Source: BI

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