The January Barometer
Historically, the S&P 500 performance in the first month of the year has an 88% chance of indicating where the index will end the year, according to Stock Trader’s Almanac. Since 1950 there have been only 8 years the trend didn’t hold. Although the “January Barometer” has had a strong success rate over the last sixty years, it has not proved to be a good predictor three of the last six years. Thus, you had a 50/50 chance of being right, guessing up or down, for the year following the January results. This indicates to us, once again, no person or no secret formula can accurately time the market or predict with any sustainable consistency its direction.
Volatility and Loss
Let’s take a few minutes and discuss the difference in volatility and risk. Volatility is what we have been experiencing in the market over the last several months, even years. Volatility is temporary price declines in the market. Last month, the market had 12 days down and 8 days up, and 8 of those trading days had price swings of greater than+ or – 1%. Since 1980, the market has averaged intra-year corrections of -14.2%, yet, since 1980, the market is up 1,807% from 107.94 to 2,058.90 (Dec 31, 1979 – Dec 31, 2014). We will continue to experience such volatility in the future.
Risk, on the other hand, is a permanent loss of value and for equity investors that happens when fear and panic force them to make poor decisions to sell out of the market, many times at market bottoms. Fear and panic are emotions and not intellectual failings. You cannot reason with fear and reasoning is especially difficult at market bottoms when fear may be at its highest.
There is a critical difference between volatility, temporary market declines, and permanent losses. As we have explained, volatility is here to stay and market moves up and down will come and go. However, history suggests that in a well-diversified equity portfolio permanent losses are only locked in when you sell.
The Fundamentals that have fueled equity gains in recent years remain in place. Even as the Federal Reserve Board (Fed) ended its controversial bond-buying program last October, the Fed Funds rate is expected to remain at historically low levels through at least the end of 2015 and possibly beyond.
In the Fed’s most recent statement (January 28, 2015) the tone had several minute, but significant changes. “Economic activity has been expanding at a solid pace.” This was an upgrade of the economy from “moderate” growth to “solid” growth. Second, the Fed will remain “patient” as it eventually hopes to start normalizing policy. This statement was consistent with previous pledges to hold rates low for a “considerable time.”
As outlined above, with respect to the Fed, we will get volatility around the Fed’s first rate hike in nearly a decade. There are no guarantees when it comes to Fed policy, but if US employment and economic growth continues at the current pace, the Fed has signaled rates will start rising in 2015. To its credit, the Fed’s rate hike is data dependent and not based on an arbitrary date in the future. Although it is doing its best to telegraph its intentions, markets could get jittery in the interim.
While strong fundamentals remain in place, risks never disappear, even in a diversified portfolio. We can manage but not eliminate risk. So that leads to the next question – what may be some of the events that could create or accelerate volatility.
Oil and Russia
The year ended with oil near $50 per barrel. I recently saw a story in Reuters that noted $150 billion in energy projects around the globe face the axe. That means there will be winners (the consumers) and losers at current prices, though the net gain to the economy should be positive. Meanwhile, Russia is undergoing a wrenching adjustment, as its energy-dependent economy must adapt to the new reality.
Any escalation of geopolitical tensions, ranging from Russia shutting off natural gas exports through the Ukraine to an intensifying of the situation in the Middle East, could spill over to the financial markets. A harder than expected landing in China would also have major negative implications with fallout spreading to the emerging and developed world. Should Europe slow, the resiliency we have seen in the US may begin to falter.
We always stress the importance of being comfortable with your portfolio. As we’ve talked about in our meetings, our goal is to help you mitigate that risk. But you must be comfortable with the level of risk you’re taking as we set out to meet your objectives. If you are not, let’s talk and recalibrate.
Markets rise and markets fall, but unless there have been changes in your circumstances or you’ve hit milestones in your life, such as retirement, stay with the plan. By itself, a record high in stocks isn’t a good reason to bail out of stocks.
We hope you’ve found this review to be educational and helpful. Let us emphasize, it is our job to assist you! If you have any questions or would like to discuss any matters, please feel free to give us a call.
As always, we are honored and humbled that you have given us the opportunity to serve as your financial advisors.