2019 Q3 Quarterly Update

Global equity markets muddled along through the quarter with little change. The MSCI All Country World Index, a barometer of equity-market performance throughout the developed and emerging countries, ended the quarter up 0.10%, bringing the year to date returns for the index to 16.71%.

Examining some important components of that Index, we find that the S&P 500 Index returned 1.70% for the quarter, and 20.55% for the calendar year so far. Developed international markets, as measured by MSCI Europe, Australasia and Far East Index, were down 1.00% in terms of the US dollar. Year to date, the EAFE Index has nevertheless managed to grow 13.35%. US small capitalization stocks suffered a hit of 2.40% in the quarter, for a return since the beginning of the year of 14.18%. Emerging market meanwhile were down 4.11% in the quarter; despite that, they are up 6.23% for the year to date.

Real estate was smoking hot in the trailing three months. The FTSE NAREIT All Equity REIT Index was up 6.83% for the quarter, bringing year to date returns to a remarkable 24.64%.

Reflecting recent downward pressure on interest rates by central banks, the broad US bond market, as measured by the Bloomberg Barclays US Aggregate Bond Market Index, returned 2.27% for the quarter and 8.52% for the year so far. The FTSE World Government Bond Index, which measures global bond market total returns, earned 0.85% for the quarter and 6.27% since the beginning of the year, both in US dollar terms.

Financial markets in general have been relatively quiet for most of 2019. That could change at any moment, of course, as it did during 2018, when 400-point days on the Dow Jones Industrial Average – the index that always leads the financial news – began to seem like they might be the new normal. In recent months, 250-point days have come to seem rather ho-hum.

Yet every investment professional who was working at the time – as the founders of this firm all were – remembers exactly where he was on October 19, 1987, when he saw the Dow Jones Industrial Average drop 508 points for the day: a staggering 22.61% crash in a matter of hours.

500 points on the Dow in one day still feels like a bit of a head snapper. And we seem to be having many more days of that magnitude in recent years. Indeed, quite a few days are much larger.

Is the market more volatile than it used to be?

Not really; not when we consider volatility in terms of daily change in percentage, rather than in points.

Consider the chart below, in which daily volatility from the end of January 1985 through the beginning of January 2019 as expressed in index points is charted in blue, while volatility in percentage terms is charted in red.

Black Monday 1987 is clearly to be seen on the chart. It’s that sickening red line reaching up and above the 25% volatility gridline (the right-hand y axis). The percentage volatility on that day was far, far greater than any we have seen since.

Meanwhile, over on the right side of the chart, notice the blue line extending up to the 1600-point gridline (the left-hand y axis). That unnerving blue line is the measure of intraday volatility on the worst day (so far) in the history of the Dow Jones Industrial Average, as measured in points: February 5, 2018. Pretty scary, right? But the percentage change on that day was 4.6%; only 20% of the percentage volatility of Black Monday in 1987.

What the chart seems to indicate is that while volatility in points has been gradually and ever so slightly increasing since 1985, volatility as a percentage has been gradually and ever so slightly decreasing.

And, of course, when we measure investment returns – when, that is to say, we measure what really matters to investors – we don’t use index points as our metric. We use percentages. The points simply don’t matter, except insofar as we express them in terms of percentage changes.

Looking at volatility of the S&P 500 Index in percentage terms from January 1990 through December 2017, we can get an idea how likely it is that we will see either a big up or a big down on any given day:

Considered in this way, daily volatility is revealed to be a rather stable and well-behaved aspect of investing. Investors who are emotionally detached from the crises of the day, and who take the long view, in the knowledge of what economic history teaches us, can therefore afford to relax about it. Volatility is the long-term investor’s friend. It is the reason such investors generally earn returns greater than the risk-free return.

The reliability of volatility is the reason we shall continue to counsel our clients to take it as an ultimately beneficent feature of investing, rather than a merely irksome bug; and, not to shirk it, but rather to assume its risks prudently, by diversifying properly.

We welcome your comments or questions about the topics covered in this post, and of course about the strategies we have employed to control the volatility of your portfolio, or any other aspect of its policy and structure, its history, or its likely future behavior.

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