The illustration above highlights the calendar year performance for the S&P 500 Index (S&P)² since 1928. Do you know what percent of those years the stock market was positive or flat compared to negative? The answer is 71% and 29%. Historically, stock market investors have been favored by a positive ratio of approximately 2-1. But should this ratio bias their investment decisions and cause complacency? How easy it can be to forget that price volatility within individual calendar years can be significant.
Consider 1987 as an extreme example. The S&P began January 1987 around 242 and rose to 336 by the end of August, rising almost 39% over that time. By the beginning of December it dropped to 225, declining almost 33%. By the end of the year it scratched its way higher to close at 247. So even though in hindsight the S&P finished the year in the positive by a boring few percent, the actual experience for the investor was anything but boring.
When experiencing positive trends like at present, with downside price volatility almost nonexistent, can investors become too complacent with investment decisions; specifically, how they manage risk? After all, stock markets rise and fall. Prices ebb and flow. Before becoming eager to chase new money into what seems to be a runaway stock market we believe you should pause, take a step back, and reflect on what history has taught us. Rather than buying more stocks with the expectation they will continue to rise, maybe it is time to challenge your perspective. Rather, we believe it may be prudent to begin looking for opportunities to add protective hedges to your existing investments in an effort to help protect any unrealized gains during the next price correction. We will discuss one way to attempt to accomplish this in one of our upcoming articles.
Illustration courtesy of Macrotrends – www.macrotrends.net/2526/sp-500-historical-annual-returns.
¹ Blue Line Investing (BLI) is an alternative to traditional wealth management. BLI uses a disciplined, rules-based investment process to seek investment opportunities, regardless of whether financial markets are rising or falling. Based on technical analysis research, the process applies trend-following using specific Exponential Moving Averages (EMAs) of the market along with other technical indicators. A moving average is a widely used indicator in technical analysis that helps smooth out past price action by filtering out the “noise” from random price fluctuations. EMA’s can be calculated for any time period. Some examples include the 5 day EMA; 50 day EMA; and 150 day EMA. We have attempted to simplify this by calling the various EMAs we use in our process the “Blue”, “Purple” and “Green” lines.
² The S&P 500 Index is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy. It is comprised of 500 large companies having common stock listed on the NYSE or NASDAQ. The volatility (beta) of the account may be greater or less than the index. It is not possible to invest directly in this index.
Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volumes. Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets may not always follow patterns. There are certain limitations to technical analysis research, such as the calculation results being impacted by changes in security price during periods of market volatility. Technical analysis is one of many indicators that may be used to analyze market data for investing purposes and should not be considered a guaranteed prediction of market activity. The opinions expressed are those of Blue Line Investing. The opinions referenced are as of the date of publication and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs.
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. This information is intended for educational purposes only and should not be considered financial advice. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.
Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.