Market See-Saw Brings Us Back to April 2010 Double-Digit Third Quarter Losses Erase Previous Gains

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If history repeats itself, I should think we can expect the same thing again.
Terry Venables, former soccer player and media pundit

Stock markets around the world plummeted in the third quarter, with the US market losing 16% and foreign markets faring somewhat worse with 17% losses.  This quarter’s loss reverses the gains of the first quarter and brings year-to-date returns below water, with domestic markets losing 11% and foreign markets losing 13%. Taking a longer view, the losses in the past five months retraced the gains of the previous year, so we stand today in about the same place as we did in April 2010.

S&P Index courtesy of MSN Money

Many have pointed to the VIX volatility index as a reliable worry barometer. In October of 2008, just two months into the start of the five-month crash, the VIX soared above 80, which is about twice where it stands today. As shown in the chart below, the recent market setback was associated with an increase in the VIX. You can also see the significant volatility in both the S&P and the VIX, reflecting the high degree of uncertainty that characterizes our economic crisis. What will happen to Greece, the euro, inflation, jobs, politics, GDP, our national debt, and the list goes on. It is very disconcerting.

CBOE VIX

We can use the past as a guide to work through this mess, making decisions about the future. Let’s look in detail at how the US market has performed so far this year and then how foreign markets have fared.  I’ll conclude with a warning to fiduciaries regarding target-date funds.

The year-to-date in review

I examined the performance of the S&P500 and EAFE indexes using attribution analysis described at StokTrib. You should perform similar analyses on your own portfolios to know why you are succeeding or failing, so you can adjust accordingly.

US stock market

I begin with an analysis of the style composition and performance of the S&P500 as shown in the next exhibit. A quick explanation of this graphic is available at Performance.

The portfolio in the exhibit is the S&P 500 index and the benchmark is the entire U.S. stock market. Let’s begin with a discussion of the style make-up of the S&P as shown in the bottom of the graph. Unsurprisingly, the S&P has a large-company orientation, tilted toward large-value companies. The total market is about 30% large-cap value, whereas the S&P is 40% large-cap value. This orientation was in favor, causing the S&P to outperform the total market. The S&P has lost 8.67% in the year-to-date, defending well versus the total market’s 11.12% loss. All of the S&P advantage arose in the current quarter; it had been lagging the broad market through June. The S&P also lagged the total market in calendar 2010.  In other words, large companies made a come-back in the 3rd quarter.

Portfolio vs. Peer Group