3 S&P 500 Milestones That May Scare You Going Into 2018… But Should They?
2017 was my 33rd year of working in the financial markets. As a student of the markets, I like to dig into the data to uncover the story behind the performance of a wide range of indexes. Since the S&P 500 Total Return Index (“S&P 500”) is one of the most followed indices, I chose it as this year’s index to review. I evaluated a number of different data points, but here are three that really caught my attention: 1.) the S&P 500’s record breaking low volatility, 2.) the significance of the tech sector’s impact on the index’s total return, and 3.) the number of consecutive years with a positive return. Data points like these make it very easy for emotion to find its way into the investment decision making process. Let’s try to understand why.
1.) The S&P 500’s Record Breaking Low Volatility
The lack of volatility was widely discussed by the financial press and research analysts throughout the year. It wasn’t so much that it was low, but how low. To put in perspective just how low the volatility was for the S&P 500, it recorded its lowest calendar year volatility in the past 40 years. The standard deviation of the S&P 500 for 2017 was a mere 3.77%1.
The chart below illustrates how the S&P 500 stacks up against its 40-year historical average and it’s not even in the same zip code. Just as remarkable is the Sharpe Ratio.
During 2017, we were able to take advantage of this low risk environment. In our Global Wealth Strategy (GWS) portfolio, we maintained an average allocation to non-fixed income assets of 69.43%, well above the since-inception2 average of 60.54%.
2.) The Significance of the Tech Sector’s Impact on the Index’s Total Return
Additionally, just simply looking at the S&P 500 doesn’t tell the entire story. The 23.8%3 weight of the Technology Sector makes it the largest in the S&P 500 for 2017, and it was also the best performing sector with a return of 38.83%4. This outsized return by the highest weighted sector can mask how the rest of the S&P 500 sectors performed. To put this in perspective the average return of the other 10 sectors was 14.63%5.
Although not prudent, indexes and managers with concentrations in the Technology Sector were rewarded in 2017. We don’t believe in making bets and chasing a “hot” sector. We are willing to forego additional returns to keep the portfolio properly diversified and avoid concentration risk. In fact, we generated an estimated net return of 12.65% with only a 1.38% average allocation to the S&P 500 Technology Select Sector SPDR ETF (XLK).
3.) The Number of Consecutive Years with a Positive Return
Another interesting fact is that 2017 marked the ninth consecutive up year for the S&P 500. When I looked back at the historical returns of the index, I found that this has happened only one other time since 1936, which was the 9-year period that preceded the tech bubble. Historically, the index has never been up for 10 consecutive years.
Many managers may place a bet based upon this rare occurrence and their perceived probability of a down year, leading them to make a significant change in their asset allocation. To us, this is a meaningless statistic that is more of a novelty. It has no impact on how we make investment decisions and manage portfolios.
These facts alone can cause emotion to creep into investors’ decision making and cause them to be anxious whenever the markets see a big down day or negative month. Many of you have experienced the aftermath of these types of emotional market-timing decisions (or lack thereof). The foundation on which GWS was built is designed specifically for this type of scenario. Our disciplined, repeatable investment process will enable us to respond appropriately as market risk changes.
1Calculated using monthly returns on the S&P 500 Total Return Index for 2017.
2GWS Inception: 7/1/2015.
3“S&P Dow Jones Indices.” S&P 500®, 31 Dec. 2017, us.spindices.com/indices/equity/sp-500.
4S&P 500 Information Technology Sector Index Total Return. Source: FactSet
5Simple average of 2017 returns of all S&P 500 Sector Indices excluding Information Technology.
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