Everyone remembers the Financial Crisis. The passage of time makes it seem like a bad dream now, but its lessons should still resonate with all of us. Since the markets and the economy have substantially recovered from this terrible time, we’ve shifted our focus to following U.S. stocks for the past few years, and this shift has lulled many investors into complacency about double-digit returns.
We focus on the S&P 500 Index because it is a very popular market barometer. However, it is a benchmark for ONLY U.S. stocks, which are just one component of a properly diversified portfolio. The S&P 500 should not be the sole index that we follow. Non-U.S. stocks, bonds and real estate are a few of the asset classes we invest in, and they have decidedly different characteristics and performance compared to the S&P 500. That said, what’s ahead for prospective returns for the S&P 500?
The S&P 500 has grown an average of 16.24% per year for the past 5 years, according to Morningstar data (through 7/31/2015, including dividends). At that rate, the S&P is doubling every 4.4 years. That’s unusually fast. Since 1926, the S&P 500 has doubled every 7.1 years, with an average return of about 10.09% per year (including dividends but not adjusted for inflation). It’s unlikely that an investor has his/her entire portfolio invested in an S&P 500-like investment, but it is a good proxy for what the large-cap sleeve of a diversified portfolio might have done.
At this point in the recovery, a 16% annual growth rate is most likely not sustainable for the S&P 500 index, but many investors are now expecting at least that. Some are also thinking they should be able to beat the index regularly even if it’s growing at 15%. This expectation can produce complacency or excessive risk-taking, more commonly called greed. Both mindsets typically lead to disappointment and costly lessons.
We firmly believe that investor behavior, not analysis, is what drives markets. Yes, short-term decisions are based on some data review, but look at the recent market volatility around earnings releases. We’ve seen some sharp sell-offs in individual U.S. stocks because they didn’t meet already lowered expectations for quarterly earnings. Markets are being driven by bad news and fear. In this uncertain environment with so much going on in the global financial world, we urge everyone to remember what happened in 2008-09 and prepare for more realistic returns in the years ahead, including some potential down years. As a refresher, here’s a brief market review ‘by the numbers’:
- -53%: That’s the amount the S&P 500 declined during the heart of the crisis. It’s measured by the drop in prices (without dividends) in the index value from its high on May 19, 2008 to its low on March 9, 2009. It was one of the worst declines in market history.
- 3.2 years: Based on the S&P price index, that’s how long it took to recover from that gut-wrenching drop in value. The S&P price index exceeded its pre-crash high on May 12, 2012.
- +211%: The growth in prices from the low to the end of July 2015. If we include reinvested dividends, the return jumps to +256%. On an annualized basis, the S&P 500 grew at a 19.42% rate for prices, and 21.96% with dividends. That’s a very strong bull.
To put all this in perspective, here’s a brief table with S&P 500 returns across three different periods:
We’re happy U.S. stocks have done so well over the past few years, but we need to remember that stocks don’t just go straight up. Without the periodic ups and downs in the market, prices and values would be meaningless. Let’s add a little more perspective and review the types of declines the S&P 500 has had since the end of World War II.
- There have been 75 declines in the 5%-10% range since 12/31/1945. That’s an average of about one per year since 1946. These types of declines are common and typically speed bumps in the market.
- There have been 25 declines in the 10%-20% range, or about one every 2.75 years. These declines are more serious, but manageable for investors who are prepared and appropriately positioned for long-term targets.
- There have been 8 declines in the 20%-40% range and 3 declines over 40%. These big drops mean that you shouldn’t be surprised to see a decline of at least 20% in the S&P 500 every 6.27 years. Realistically, you should be prepared for a 30% drop in the S&P at some point as a long-term investor.
It shouldn’t be a surprise that the U.S. equity market is volatile and sometimes drops in value. The good news is long-term investors have recovered from most of these declines in a relatively short period of time. The 5%-10% declines took an average of just one month to recover; 10%-20% declines took just 3 months to recover; 20%-40% declines took a little more than a year to recover, and 40%+ declines needed almost 5 years to recover. The key concern we have is that investors might be getting a little ‘fat and happy.’ Recent returns have promoted this mindset and are skewing decisions by causing people to don rose-colored glasses. At this point, assuming that this level of returns will continue, or that ‘taking risk’ and investing in the market now will provide immediate growth, is a dangerous fallacy.
At JJ Burns & Company, we believe that a well-managed portfolio mitigates risk while also recognizing that risk and volatility are not synonymous. A single index is NOT an appropriate portfolio benchmark; your long-term goals are, and one year is a small time period in your investing life. Properly managed portfolios are diversified and help clients avoid behavioral-finance traps that have been proven to produce unappealing returns.
If you’re concerned about risk in your portfolio, feel free to schedule an appointment with our team. Investors who review their long-term goals now and make adjustments for increasing volatility are more likely to reach their benchmarks and sleep better at night.