Market Perspectives – A Special Commentary by Dylan Minor PhD – Q4 2015
1/8/2016
Happy New Year!
After we enjoyed a Santa Barbara-like weather holiday in Boston this year, Winter has finally arrived! Similarly, many stock markets have started the year with a chill.
Some market pundits have already begun to ask if 2016 is another 2008. How could they make such a claim? Well, in the first few trading days of the year stocks have fallen, and some might believe that this suggests a negative return for the year.
A bit of big-picture perspective here. Sometimes stocks go down. That’s why they’re called risk assets. Half of all years since 1950 have seen a double-digit correction in stocks. This is also a time to re-emphasize how your portfolio is constructed. Yes, stocks have declined some, but bonds and some alternative investments have gone up in value during the same period. Diversification is the only antidote for uncertainty. Although diversification does not guarantee against loss in a declining market, a properly constructed and well diversified portfolio is a key component of a successful investment experience. We never know what the next several months (or years!) of returns will be, and so instead we need to have exposure to different markets that do not all depend on one sector or index. This is exactly the process we follow with our proprietary States of the World Wealth Managementtm process.
And this is what happened in 2008: For the full month of January in 2008, the SP500 index fell roughly 6%–and then the index went on to end the year with a thud, falling a total of 38% for the year. That sounds scary, so let’s do a little more research together. What happened in a year when January yielded an even greater 9% loss (by the way, we’ve fallen about half this much so far this year)? Well, that is what happened in 2009, and the SP500 ended the year up a whopping 23%. In 2010, January yielded another 4% drop, but then the SP500 ended up 13%.[1]
To get the full picture, I just analyzed returns for the past 28 years, I found some interesting facts. First, for any given year, the return of the stock market in January has a correlation of just .06 with the next 11 months of total return. This means that January’s return is essentially random in relation to the next 11 months of returns for a given year.[2] In fact, for almost 40% of the years, January even predicts the rest of the year’s returns in the opposite direction. That is, a negative January return is followed by a total positive return over the next 11 months (and vice versa if January yields a positive return), some 40% of the time. In short, we do not want to become too concerned with a negative return in January, yet alone during its first week. So if you want to predict the rest of the year’s returns, asking Bryan’s two French bull dogs (which maybe you’ve seen at the office recently!) to bark out the rest of the year’s return should prove an equally good prediction to using January’s return.
Stepping back and looking at the big picture, the underlying US economy is still doing well. Indeed, the FED would not have begun our interest “liftoff” if it were otherwise and today we just received strong employment numbers. Also important is that this is all a good reminder of why we do not want to have all of our money placed in the SP500; Whatever the case, rest assured that we are closely monitoring the markets. In the next week or so you’ll see my quarterly commentary, providing a recap of 2015. Also, I have been deep in research since arriving at Harvard last July and have constructed some further refinements to our process and offerings that you’ll see in the coming weeks and months, so stay tuned! As always, don’t hesitate to call or write any of us should you have any concerns, as we are here to serve you!
[1] Note that for simplicity all return figures are based on index values and are thus exclusive of dividends.
[2] For those of you that are like my wife Caroline who is smarter and more interesting than I am and thus didn’t enjoy taking statistics, a correlation of +1 means that one item perfectly predicts variation of another item in the same direction, a correlation of -1 means that one item perfectly predicts the variation of the other item in the opposite direction, and a correlation of 0 means that there is no relationship.
This commentary reflects the personal opinions, viewpoints and analyses of the Omega Financial Group, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Omega Financial Group, LLC or performance returns of any Omega Financial Group, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Omega Financial Group, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.