The January Blues

Sam Swift

Feb 4, 2016

By: Sam Swift, CFA, CFP®

January was a poor month for stock markets. U.S. stocks as measured by the S&P 500 were down almost 5% and there was no respite to be found globally as international markets had similar declines. Even those numbers don’t tell the entire story as all of the damage was done in the first two weeks. For what it’s worth, the S&P 500 had the worst start to a year in history when it was down nearly 8% through January 15.

Of course, my intent here is not to scare you further—you can find plenty of doom and gloom elsewhere. As usual, we’ll look at some numbers to put these short-term market fluctuations into perspective.

Given that January performed poorly, it’s reasonable to ask whether or not that may tell us anything about the rest of the year. After all, if we can make an accurate prediction about the future then deciding how and when to invest becomes quite a bit easier (warm up those crystal balls!). The red dots in Exhibit 1 represent January returns each year and the blue bars are the returns for the rest of the year.

Historical Returns

According to research by Dimensional Fund Advisors, “a negative January was followed by a subsequent 11-month return that was positive 59% of the time, with an average return of 7%, indicating a negative January does not predict poor market returns for the rest of the year.” Hopefully this is obvious to readers here—there is no actionable information to be had from the returns in January or any one month for that matter.

Markets are forward looking. That is, current prices reflect all information and future expectations of market participants. Right now, in aggregate, there are more pessimistic views of the immediate future than optimistic, but the key is that this pessimism is already priced in. Future news can be poor, but as long as it beats expectations it’s likely to result in increasing market prices just as further bad news that’s worse than expectations can continue to drop stock prices. Unfortunately it’s extremely difficult to know what future events are to come and nearly impossible to know how investors will react to them. If you wait for the bad (or good) news, it’s already too late. Far better to stay invested all the time where we expect positive returns.

It’s also worth looking at market returns following corrections (10% drops) and official bear markets (20% drops).

Annualized Compound Returns

Here again, we see that market returns are significantly positive following both corrections and bear markets on average. This is obvious when you think about it—what follows a bear market? A bull market!—but it frequently gets lost in the midst of declining market values.

When investor’s nerves are on edge, of course, they’re thinking much more about the short-term than the long-term. Their concern is not the next three years, but rather the value of their investments dropping another 30% over the next six months. This is a completely valid reaction, by the way. With the 2008-2009 financial crash still fresh for most, it’s hard to remember that market declines rarely go that deep. In fact, the S&P 500 has only had 12-month declines greater than 35% 26 times in its history. That’s 26 times out of 1081 possible chances. And 18 of those times occurred in the 1930’s! After a significant market fall, the odds are much greater that future returns will be positive rather than continuing to drop—stocks have just gone on sale after all.

Numbers and data, of course, can be cold comfort in the midst of a downturn. The most important thing you have going for you is that you have a plan that has factored in frequent market volatility. This won’t be the last time you face rough markets, but sticking with your well-thought-out allocation through the ups and downs is what maximizes your chances of meeting all of your goals.

 

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