MARKET VOLATILITY - FRIEND OR FOE!

When the market goes up we love it,  when the market goes down we loathe it!                                                                                                                                                                                                                       

WE SHOULD EXPECT VOLATILITY

It is important to remember  how well-functioning capital markets work and what prices reflect; prices reflect the aggregate expectations of market participants.  Risk averison, investors' tastes and preferences,and expectations about future profits are among the many inputs that affect expectations.  We should expect these inputs to vary day-to-day.  Markets adapt to changing expectations and new information.  As a result, we expect prices, as well as the level of volatility, to fluctuate.

JANUARY 2016

Do returns during January provide information  about returns during the remainder of the year?

As we would expect over any period, prices in January 2016 changed from day-to-day as expectations changed and investors processed new information.  The market events of January 2016 provide an opportunity to examine several questions important to investors and revisit some "fundamental principles of investing in capital markets."  Some investors may wonder whether the returns in January have some predictive power for the returns during the remainder of the year.  Looking at the S&P 500 Index for the month of January compared with the subsequent 11-month return (i.e., February through December ).  We find that a negative January was followed by a subsequent 11-month return that was positive 59% of the time, with an average return of 7%, indicating a negative January does not predict poor market returns for the rest of the year. One additional note: if we look at the five lowest January returns, excluding January 2016, the average return for the remainder of the year was 13.8% and none of these years finished in the lowest 20 years of annual returns for the S&P 500 Index.

VOLATILITY

Is the recent period abnormally volatile?

From January 1926 to December 2015, the S&P 500 had a compound return of 10.02% and a standard deviation of 18.85%.  From January 2010 through December 2015, the return for the S&P 500 has been 12.98% with a standard deviation of 13.09%.  Comparing these results with other historical periods, we can see the recent period has not necessarily been more volatile.

IMPORTANCE OF DISCIPLINE

While in the midst of a market downturn, we may be inclined to look for some type of  signal as to what the recent period means for future returns.  Before jumping to conclusions or attempting to make predictions about what the future may hold, looking at all the data can provide perspective.  While the realized return over any period may be positive or negative, in expectation we believe markets will go up.  As investors, we should remain disciplined through all periods in order to capture the expected returns the market offers.

The data referenced in this article was supplied   by DIMENSIONAL FUND ADVISORS.