These past few weeks, with the year winding down and investment strategy decisions to think about (always), I spent a lot of time with my research team analyzing historical stock market index data as far back as 1871.  First conclusion: I am sick and tired of analyzing historical stock market index data!  We did this to see what today’s investor might learn from market history.

Why now?  Because we are at a precarious point in stock market history.  Given the strong market returns of the last half-decade or so, recent market index returns are in rarified air.  And while there is certainly historical evidence that when markets surge as they have since the S&P bottomed in early 2009, there is trouble ahead, there is plenty of evidence to say that this object (the market) that has been in motion since that time can stay in motion for a while.  As hedged investors, we are always trying to figure out how to do what we do better.  Historical analysis like this is a key part of that.

Rather than exhaust you (and lose your attention along the way) with the guts of our analysis, let me just start 2015 with a summary of our observations and conclusions.

 

S&P 500 INDEX (Total Return through 12/29/14) – RECENT PERFORMANCE HISTORY (Ycharts.com 2014)

  • Up 236% since 2/28/2009
  • Up 102% since 2/29/2000

HISTORICAL OBSERVATIONS

  • Depending on what time frame you look at, the stock market has either done very well or just OK in a historical context. Buried within this time period is a pair of 40%+ declines.  The S&P 500 Total Return has an annualized return of 5% in about the past 15 years but an annualized return of about 23% in about the last six years.
  • There is no definitive historical pattern we have found that says “do this” or “do that” to succeed after a 200% run-up in stock prices
  • Markets can go up a lot longer and lot higher than any of us imagines
  • Yet, major declines following major advances are inevitable…it is just a matter of how long it takes until the market peak occurs, and how deep the eventual drop will be
  • The threat of a major decline following a more than 200% rise in the S&P 500 Index since early 2009 is real. But who knows when it will come home to roost?  Certainly not us.  But our approach is not based on guessing, it is based on accounting for many different scenarios.
  • Whatever cushion bonds provided in the past is largely gone, due to interest rates which persist at levels well below normal for an economic recovery

IMPLICATIONS FOR INVESTMENT PLANNING

  • Enjoy the ride up, but it is essential to have as part of your investment process a clear-cut approach to combating major declines in stock prices
  • Rather than try to determine when a life-changing market decline will happen and what will cause it, make proactive risk-management a part of your ongoing strategy…not only when market turmoil occurs, but always
  • Investing to track a major market index like the S&P 500 has had a very good run the past half-decade and is now immensely popular. But do not be fooled into thinking that recent past is prologue.  The S&P 500 Index, after strong runs higher like this one, becomes a list of past winners. And with all the money now invested in index funds, when it goes the other way, the unraveling can be quick and thorough as we have seen twice in the past 15 years.
  • Instead, be prepared to diversify your equity portfolio along some additional dimensions, beyond sectors, market cap sizes, etc. such as:

1. Holding period diversification

2. Investment theme diversification

3. Dividend level diversification

 

THE SUNGARDEN TEAM WISHES YOU A VERY HAPPY AND PROSPEROUS 2015!!

© Sungarden Investment Research

www.sungardenresearch.com

 

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