2018 was an interesting year for the stock market with many lessons for investors. After about 9 years of thriving, the S&P 500 started the year up nearly 7% in the first few weeks of January1. The S&P 500 then had the “long-awaited” correction that market pundits had been predicting for years.
In case you need refreshing on stock market terminology, a correction is a 10% drop from market highs, while a bear market is a 20% decline.
The correction was short-lived, lasting about a week before stocks stabilized. The first quarter ended as a mixed bag as the S&P 500 had a -0.76% return while other indices such as the Nasdaq (+2.32%) and MSCI Emerging Markets (+1.33%) had positive returns for the quarter2.
The S&P 500 slowly but surely climbed higher after Q1 and by late August had returned to the high prior to the January/February correction. The positive performance continued through the end of the third quarter as the S&P 500 was up nearly 9% for the year3.
The positive returns stopped there for the year as the fourth quarter saw another correction and even a brief dip into bear market territory. All stock indices faced losses for the fourth quarter including: -13.52% for the S&P 500, -20.20% for the Russell 2000 (small cap stocks), -12.50% for the MSCI EAFE (international stocks)4. This was just the third time that the S&P 500 had a correction, returned to the highs and then had another correction in the same year (1946 and 1947 were the other two times)5. While such statistics are interesting, it can make it seem like the current market isn’t functioning normally.
However, when looking at the bigger picture, what we’re experiencing in the market now is simply par for the course. It is helpful to remember how the recent ups and downs are more normal than the relative calm in the markets during 2017 and early 2018. It can feel like it has been all positive since 2008/2009 but the chart below shows a different picture5. This chart shows the years since 2008 that the S&P 500 had at least a 10% drawdown from the market highs of that calendar year and also shows the full year return of that year.
|Year||Max Intra-Year Drawdown||Full Year Return (S&P 500)|
2018 ended with a 20.3% max intra-year drawdown.
If we expand our view back to 1950, we see this is also a fairly common occurrence5.
|S&P 500 Drawdown Level||# of Years|
|Greater than 20%||11|
|15% - 20%||10|
|10% - 15%||16|
|5% - 10%||26|
|Less than 5%||5|
The next logical step is to ask if there is any insight we can gain from this information or if there are any adjustments that should be made.
Last year’s 20.3% drawdown is technically a bear market (even though we’ve recovered from that low). There are some who will argue that a bear market precedes an economic recession and portfolios should be adjusted - that is not a certainty. This is the 21st bear market since 1929. Of the previous 20 bear markets, only 11 coincided with a recession6. This not an accurate predictor of future returns and another reason we don't make changes to your portfolio based upon such predictions.
We also believe that we shouldn’t be looking to investment gurus to help us understand what happened last year and what that means for 2019. This is the time of year when most Wall Street firms are making their forecasts for the year, but if history has taught us anything, it’s to ignore these forecasts. The forecasts between 2000-2014 missed the actual market performance by an average of 14.6% per year7. We wrote a post titled Should You Invest Based on Investment Gurus? about that statistic and many others that you may want to read.
If we don’t look to investment gurus, what are we considering?
To start, while we certainly did not enjoy the past quarter, we know that periods of negative returns are normal in investing. Historically, the market makes all-time highs on about 5% of trading days, which means 95% of the time we’re trading below an all-time high8. We don’t expect that fact to change any time soon. We’ve written in more detail in our post.
Speaking of all-time highs, we wrote back in August of 2016, the post. The point of the post was not predicting the future (we had no idea the market would hit so many new all-time highs in the two years since we wrote that), but rather that we should acknowledge that we don’t know what will happen in the short-term and instead focus on what we can control. This is still our belief today.
We believe smart investors avoid market timing and trying to guess the direction of the market, look beyond the headlines – including predictions by investment gurus, and have low-cost and highly-diversified portfolios.
1Source: Yahoo Finance https://tinyurl.com/y7h38jjo
2Source: LPL Research, Daily Performance Reports Month End 3/31/18
3Source: Yahoo Finance https://tinyurl.com/yaltuplp
4Source: LPL Research, Daily Performance Reports Month End 12/31/18
5S&P 500; Source: Ben Carlson, awealthofcommonsense.com, The One Constant in the Stock Market
6Source: Charlie Bilello, pensionparterners.com, “Markets in Turmoil” – The Upside of Downside
7Source: Would you let a mystic manage your investment portfolio, Washington Post 11/28/15 by Barry Ritholtz
8Dow Jones Industrial Average from 1915-2017. Source: All-Time Highs are Usually Followed by All-Time Highs, Ben Carlson
9Source: Dimensional Fund Advisors, 2018 Market Review
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Investing involves risk including loss of principal.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. No strategy, including diversification, can protect against market risk.