Perspectives

January was an impressive month to say the least.  The return of the S&P 500 was +5.65%, which is the best January since 1997, and the fifth best January since 1980.  With the market reaching new highs during this, the second longest bull run on record, many investors are wondering if now is the time to take their gains and get out of the market.  The equally strong pullback in the first week of February is adding to some investors’ concern.  This month, we want to address this question and provide a historical perspective.

First, we’ll address the issue of “Market Timing.”  While there are volumes of data on the topic, we will keep our analysis more simple and practical by highlighting the critical dates when, if investors were able, they should have moved into and out of the equity markets to minimize loss and maximize gains over the last 40 years.  We’ve simplified the analysis by restricting our review to the S&P 500.  The first date timers should have acted was 10/1/1987 when market timers should have liquidated their equity holdings.  They should have then remained out of equities until 12/1/1987, at which time they should have gotten back into the market.  Their next move should have been to get out of the market on May 1, 1998, and quickly re-enter the market on October 1, 1998.  Following this, they should have liquidated their equity holdings no later than September 1, 2000 with the re-entry date being April 1, 2003.  They should have remained in equities until 10/1/2008,  with their re-entry coming in early March 2009.  Then they should have sold in early June, 2015, moving back into the market in September 2015. They would have remained in equities until January 31, 2018, and known to re-enter the market on 2/6/2018, even if only for the day…

We highlight this because it’s very easy to let emotion take control, and for many of us, our human nature compels us to consider how wonderful it would have been if we could have avoided the selloffs without missing out on the gains, or in other words, timed the market.  We all know no-one has correctly called all of the dates above for exit and re-entry back into the markets, but still, our human nature compels many of us to consider, “What if we could have gotten even one of the exit and re-entry points listed above correct?”  The simple answer would appear to be that if we could have gotten out before the drop and re-entered before the climb, we would be better off.  The more accurate answer would have to include all the returns we missed out on for all of the times we incorrectly made decisions to get in and out of the market at the wrong time.  It would further have to include the impact of all the taxes we paid to liquidate our portfolios prematurely, incurring a great deal of capital gains all at one time because of our liquidation of assets.  It would also have to include the effect of drawing down principal (for those of us who take distributions from our accounts) rather than spending interest or dividend income our investments would have earned.  Even though an asset’s value may be down, we are able to spend the income it produces without reducing the number of shares we own.  By incurring the tax obligation associated with liquidating our assets, we would only be able to repurchase the same number of shares we sold IF the value was down by at least as much as the tax we had to pay.  If our assumptions behind the liquidation were wrong, we would most likely experience a prolonged reduction in investment income due to repurchasing less shares than we sold, which could materially alter our investment expectations.

With that behind us, we also wanted to address some of the headlines that have been present in the press during the last week.  A number of market pundits have boldly proclaimed that rising rates and/or rising inflation are the culprits for the market’s selloff.  We find this interesting given what has historically happened in a rising rate and a rising inflation environment.  Below, we have highlighted periods of strong rate increases (the 10 Year Constant Maturity Treasury Rate) and rising inflation from the mid-1970s until today.  We have also shown what the S&P 500’s performance was during the period and in the 12 months immediately following the period.

In the table, we identify eight periods where the 10-year rate increased by more than 35%.  During these periods, you will notice that an increase in inflation coincided with the increase in yields.  We would expect to see this because rising rates are one of the primary tools to moderate (control) rising inflation.  In only one of those periods (4/29/83 to 6/29/84), was the market down during a period of rising rates, and the loss was not dramatic.  In the 12 months immediately following the increase in rates, again, you will see that in only one of the periods was the stock market down, and the loss was not significant.  The data does not support rising rates or rising inflation as the “cause” of February’s selloff. 

We believe it’s more likely a reaction to the strong gains experienced in January (and during all of 2017) and technical indicators.  While we rely more upon fundamental data (earnings, profits, GDP growth, etc), many investors rely upon technical data, and for many, it was signaling the market was due for a correction.  We believe those who engaged in liquidating will look back later in the year and realize that was a mistake, as the fundamental data continues to be strongly supportive of a growing economy and an increasing stock market.