2015 has been a tough year for investors. The data shows us that we should be thinking about how much market exposure to take on in portfolios. Since July of this year we have been tactically protecting portfolios from two major risks to equity market prices. Those risks have been:
- The Fed
- Sequential slowing of Earnings.
The data has been stating that volatility is back, and that is very hard on stock returns. It’s important to understand the process of investing. Here is a favorite quote of mine.
Rule No.1: Never lose money.
Rule No.2: Never forget rule No.1.
Warren is warning investors that capital must be protected, as much as possible to have future opportunity for growth. It is just the math of loss. If you have $1,000.00 invested that loses 10%, then it is now worth $900.00. If you then regain 10% you have $990.00, you’re not even back to break even, let alone back to growth on capital, which would take a rebound of roughly 11.2%. So, we manage the risk of equity volatility to help protect capital for future growth opportunities. This means most of you will see more cash in your portfolios on your year end statements. The time will come to put the capital back to work and enjoy your growth rewards.
Let’s look at the historical context for a better understanding.
Since 2011 the market, as measured by the S&P 500, has enjoyed a period of very low stock volatility. That makes for fairly calm waters for stocks to continue on the path of least resistance, which has been an upward bias. Of course, if you were a commodity investor, in say the gold or oil markets, that would have been false. Those markets have been declining for the past several years. But, equities have enjoyed a long expansionary period since 2011. Oh we have had our tests, like the taper tantrum of May 2013, but for the most part the sailing has been clear. Even today with the S&P 500 down -2.39% YTD thru 12/21/2015, most would not think that is so bad. However, I would challenge you to look at what index you mean.
The S&P 500 is looked at in either capitalization weight, or equal weight. You can invest in either weighting of the S&P and still be invested in the “market.” If you had been invested in the equal weight S&P 500 this year you are down -4.6% YTD through 12/21/2015. Just to clarify… that means you are down TWICE as much this year as the capitalization weighted S&P 500 index of -2.39% YTD thru 12/21/2015. Why this difference? The answer is that more of the companies in the S&P 500 are negative this year, or the stocks that are rising are fewer. We call this a narrowing of participation by equities.
The data shows us about how much market exposure to take on in portfolios. Since July of this year we have been tactically protecting portfolios from two major risks to equity market prices: 1. The Fed and 2. Sequential slowing of Earnings. The data has been stating that volatility is back, and that is very hard on stock returns.
As you can see in the above VIX chart, volatility is making higher lows yet again heading into year end. That is a warning signal that the indexes are heading into rough waters. Let’s look back to see the last time we had this type of volatility spike in equity markets.
Here is the S&P 500 for this same period of time.
The good news of this chart is that these situations usually last for just a period time. We have to be patient and manage risk as it develops. With only 6 trading session until year end, it looks like Santa’s delivery may be delayed until next year.
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The information provided for informational purposes only, and does not constitute an offer, solicitation or recommendation to sell or an offer to buy securities, investment products or investment advisory services. All information, views, opinions and estimates are subject to change or correction without notice. Nothing contained herein constitutes financial, legal, tax, or other advice. These opinions may not fit to your financial status, risk and return preferences.