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Maintaining Perspective

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Last week was rough for equity markets.

The S&P 500 fell over 4.5%, with the majority of the loss coming in Friday’s single-day drop of over 2%. This felt particularly painful when compared to the calm of 2017, when the S&P 500 never declined more than 3% from intra-year highs.

However, appearances can be deceiving. As we discussed in our recent 2018 Outlook (2017 Review and 2018 Outlook: Looking Forward to Tax Reform’s Impacts, 1/18/18), last year’s low volatility and near-constant streak of fresh all-time highs was an anomaly. History shows that low-volatility years have a tendency to be followed by higher-volatility years, so increased turbulence is a reasonable expectation. Moreover, higher volatility is not necessarily a harbinger of poor forward returns.

To keep a proper perspective, consider two important points:

  • First: after a sharp drop, it’s easy to forget what happened before the pullback. In this case, last week’s downturn was preceded by a remarkably positive start to the year. Through the first 19 trading days of 2018, the S&P 500’s YTD price return was a stunning +6.9%. Even after last week’s 4.5% decline, the YTD price return is still +3.3%.

S&P 500 2018 YTD Price Return

Source: Bloomberg

Zooming out to a slightly longer time frame, since the beginning of 2016 the S&P 500 has gained +33.9%. When viewed over this medium-term perspective, last week was merely a minor hiccup.

S&P 500 2016-2018 YTD Price Return

Source: Bloomberg

Source: Bloomberg

  • Second: sharp intra-year declines don’t necessarily translate into full-year losses. A great example of this becomes apparent if we simply zoom into the 2016 portion of the above chart:

S&P 500 2016 Price Return

Source: Bloomberg

In contrast to 2017’s calm, 2016 was far more chaotic: in particular, the first 7 weeks of 2016 witnessed a distressing -11.4% decline. Recall that this was the height of the oil-price bust, as Brent crude broke below $28/barrel and triggered fears of rolling bankruptcies across the global oil industry. However, this didn’t last – the market subsequently rebounded, and despite 2 more intra-year declines of at least 3%, the S&P 500 ended the year up a solid +8.5%.

In conclusion, don’t just assume that last week’s losses imply a lost year in equities. Economic fundamentals tend to assert themselves sooner rather than later, and they still appear quite positive in the near-to-medium terms. Again, for a more detailed discussion on our thinking on the fundamentals, please see our recent 2018 Outlook (2017 Review and 2018 Outlook: Looking Forward to Tax Reform’s Impacts, 1/18/18).

Authored by Daniel Beniak

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