By Bob Seawright
Since the financial crisis of 2007-2008, investors have been spoiled. From March 2009 through January 2018, the S&P 500 has returned 18.3% annualized. Moreover,
despite high levels during the financial crisis and spikes in
2011 and 2015, volatility has been surprisingly low for much of
the past 15 years. At the end of 2017, the S&P 500 One-Month
Realized Volatility Index dipped under 6%. For investors, high
returns and low volatility are a fantastic combination.
Such good times couldn’t roll forever. Volatility is back.
The S&P 500 One-Month Realized Volatility Index is above
25% as of early February. That level isn’t remotely unusual or
even all that high, but investors who had gotten spoiled by one-way traffic to higher prices have been spooked nonetheless.
Anytime is a good time for a reminder of the fundamentals
of market movements, and the advent of volatility after a long
absence is a particularly good time. Thus remember: Volatility
is normal and necessary.
During these sorts of transitional periods in the markets, I
am regularly and invariably asked — longingly — for “the next
Amazon.” The thinking is that if these investors could just smoke
out the next great whatever company, all would be well and investing would be easy. Good investing is never easy. It is always hard.
Finding “the next Amazon” is really hard. Over the past 90
years (through 2015), 58% of all stocks underperformed one-month U.S. Treasury bills and most lost money over their lifetimes.
The best performing 86 stocks accounted for more than half
the $32 trillion in value generated by stocks over T-bills during
that time while a mere 4% of stocks accounted for all the out-performance of stocks over T-bills. Finding any outperforming
stock is a daunting challenge. Finding “the next Amazon” in
advance is insanely difficult.
But let’s suppose for a moment that you could.
If you had invested just $10,000 in the Amazon IPO in 1997,
as of March 2018 — barely 20 years later — you would have
nearly $8 million. However, there were significant drawdowns
you would have had to endure to get those returns.
How many of us could truly stomach a 90% drawdown and
multiple 50 percenters? Even the best possible investments
suffer huge (and thus terrifying) drawdowns.
With (always 20: 20) hindsight, it may not seem like too big a
deal. However, in the moment, our loss aversion and our impulsive performance-chasing militate strongly against our being
able to hold on when investments inevitably suffer losses.
The sad reality is that when market volatility seems oppressive, many investors bail. They say they simply cannot stomach
the losses. That’s why the “behavior gap” between investment
returns and investor returns is so huge and so potentially damaging. Many — probably most — investors who cash out when
negative volatility rears its ugly head will see their chances of
retirement success decrease significantly.
Stocks generally do not offer Amazon-level returns, of course.
But the returns they do provide are very good indeed. Over the 30
years ending Dec. 31, 2017, the S&P 500 returned 10.6% vs. 6.4% for
bonds (10-year U.S. Treasury notes) and 3.1% for cash (3-month
U.S. Treasury bills) annualized. Everyone knows the differences
are significant, but it’s easy to miss just how significant they are.
Over those 30 years, $10,000 in cash netted $24,728, bonds
provided $65,123, while stocks earned $205,557. Avoiding
stocks to avoid volatility has an enormous cost.
Negative volatility hurts. Sometimes it hurts a lot. However,
volatility is the necessary price paid for the much higher
returns provided by stocks as compared with other investment
choices. Investors would be wise to willingly to pay-up.
Bob Seawright is the chief investment and information officer for
Madison Avenue Securities in San Diego. He is active on Twitter,
@RPSeawright, and his blog “Above the Market” can be found at
meaningfully equities were correcting,” he said. “For the
vast majority of investment professionals who have worked
through at least one, if not several far more severe and long
corrections (2008, 2001 and 1987), the week of Feb. 5 felt
perhaps more like a return to normality than a severe earthshaking event.”
Toohey recalls the Brexit vote of June 2016 and the asso-
ciated bout of volatility, which he saw as an “opportunity to
focus on fundamentals and valuation and to stick to the invest-
MacDonald also has a long-term perspective. “The market
was recently at an all-time high,” he explained.
“What that means to us is that for every recession we have
ever had — every depression, world war, Watergate scandal, or
energy crisis — we have survived it and gone on to new highs.
100% of time,” the portfolio manager said. “The only thing that
can derail a long-term investment plan is to abandon it when
times look tough. Stick with an intelligent wealth-manage-ment plan, and turn off CNBC.”
Ginger Szala is executive managing editor of Investment Advisor and
the former editor-in-chief of Futures Magazine Group.
Be Smart, Not Frightened, by Volatility