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.

S&P 500 Comparison

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.

Conclusion

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.

THIS DOCUMENT HAS BEEN PREPARED BY PARITAS CAPITAL MANAGEMENT, LLC (“PARITAS”) SOLELY FOR THE PURPOSES OF PROVIDING SUMMARY INFORMATION REGARDING PARITAS AND ITS GLOBAL WEALTH STRATEGY (“GWS”) COMPOSITE. THE INFORMATION CONTAINED HEREIN IS NOT, AND SHOULD NOT BE CONSTRUED, AS AN OFFER OR SOLICITATION OF AN OFFER TO BUY ANY FINANCIAL INSTRUMENT. AN INVESTMENT IN ACCORDANCE WITH THE GWS COMPOSITE DESCRIBED HEREIN HAS NOT BEEN APPROVED OR DISAPPROVED BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION (“SEC”), ANY STATE SECURITIES COMMISSION, OR OTHER ANY OTHER REGULATORY AUTHORITY, NOR HAVE ANY OF THESE AUTHORITIES PASSED UPON OR ENDORSED THE MERITS OR THE ACCURACY OR ADEQUACY OF THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL AND A CRIMINAL OFFENSE.

ANY REPRODUCTION, DISTRIBUTION, OR OTHER UNAUTHORIZED USE OF THIS DOCUMENT, AS A WHOLE OR IN PART, OR THE DISCLOSURE OF THE CONTENTS HEREOF, OTHER THAN TO THE RECIPIENTS FINANCIAL, TAX AND/OR LEGAL ADVISORS WITHOUT THE PRIOR WRITTEN CONSENT OF PARITAS IS PROHIBITED.

THE BENCHMARK INDEX REFERRED TO HEREIN IS A BLEND OF 60% MSCI ACWI INDEX AND 40% BARCLAYS US AGGREGATE BOND INDEX. THE INDICES INCLUDED TO SHOW RELATIVE MARKET PERFORMANCE FOR THE PERIODS INDICATED ARE NOT NECESSARILY STANDARDS OF COMPARISON, SINCE INDICES ARE UNMANAGED, BROADLY BASED AND DIFFER IN NUMEROUS RESPECTS FROM THE GWS COMPOSITE. MARKET INDEX INFORMATION WAS COMPILED FROM SOURCES THAT PARITAS BELIEVES TO BE RELIABLE. HOWEVER, PARITAS DOES NOT GUARANTEE THE ACCURACY OR COMPLETENESS OF SUCH DATA.

AN INVESTMENT IN ACCORDANCE WITH THE GWS COMPOSITE MAY NOT BE SUITABLE FOR ALL INVESTORS. THIS MATERIAL HAS BEEN PREPARED FOR INFORMATIONAL PURPOSES ONLY, AND IS NOT INTENDED TO PROVIDE, AND SHOULD NOT BE RELIED ON FOR, INVESTMENT, ACCOUNTING, LEGAL OR TAX ADVICE.

INVESTING INVOLVES RISK, INCLUDING THE POTENTIAL OF LOSS OF SOME OR ALL PRINCIPAL INVESTED. INTERESTED PARTIES ARE ENCOURAGED TO REVIEW PARITAS’ FORM ADV PART 2, AS WELL AS PERTINENT PROSPECTUS/PRODUCT DESCRIPTIONS TO CONSIDER SUCH RISK PRIOR TO INVESTING. THERE IS NO GUARANTEE THAT A DIVERSIFIED PORTFOLIO WILL ENHANCE OVERALL RETURNS OR OUTPERFORM A NON-DIVERSIFIED PORTFOLIO. DIVERSIFICATION DOES NOT PROTECT AGAINST MARKET RISK. STOCK INVESTING INVOLVES RISK INCLUDING LOSS OF PRINCIPAL. PAST PERFORMANCE IS NO GUARANTEE OR PROMISE OF FUTURE SUCCESS.

THE SHARES OF EXCHANGE-TRADED FUNDS (“ETFS”) MAY TRADE AT PRICES AT, BELOW, OR ABOVE THEIR MOST RECENT NET ASSET VALUE. EQUITY SECURITIES WILL FLUCTUATE IN PRICE; THE VALUE OF INVESTMENTS IN ACCORDANCE WITH THE GWS COMPOSITE WILL THUS FLUCTUATE, AND THIS MAY RESULT IN A LOSS. SECURITIES IN CERTAIN FOREIGN COUNTRIES MAY BE LESS LIQUID, MORE VOLATILE, AND LESS SUBJECT TO GOVERNMENTAL SUPERVISION THAN IN THE UNITED STATES. THE VALUES OF THESE SECURITIES MAY BE AFFECTED BY CHANGES IN CURRENCY RATES, APPLICATION OF A COUNTRY’S SPECIFIC TAX LAWS, CHANGES IN GOVERNMENT ADMINISTRATION, AND ECONOMIC AND MONETARY POLICY. EMERGING MARKET SECURITIES CARRY SPECIAL RISKS, SUCH AS LESS DEVELOPED OR LESS EFFICIENT TRADING MARKETS, A LACK OF COMPANY INFORMATION, AND DIFFERING AUDITING AND LEGAL STANDARDS.

AN INVESTMENT IN BONDS CARRIES RISK. IF INTEREST RATES RISE, BOND PRICES USUALLY DECLINE. THE LONGER A BOND’S MATURITY, THE GREATER THE IMPACT A CHANGE IN INTEREST RATES CAN HAVE ON ITS PRICE. SELLING A BOND BEFORE IT REACHES ITS MATURITY MAY RESULT IN A LOSS UPON ITS SALE. BONDS ALSO CARRY THE RISK OF DEFAULT, WHICH IS THE RISK THAT THE ISSUER IS UNABLE TO MAKE FURTHER INCOME AND PRINCIPAL PAYMENTS. OTHER RISKS, INCLUDING INFLATION RISK, CALL RISK, AND PRE-PAYMENT RISK, ALSO APPLY. HIGH YIELD SECURITIES (ALSO REFERRED TO AS “JUNK BONDS”) INHERENTLY HAVE A HIGHER DEGREE OF MARKET RISK, DEFAULT RISK, AND CREDIT RISK.

PARITAS CAPITAL MANAGEMENT, LLC IS A REGISTERED INVESTMENT ADVISOR WITH THE STATES OF CALIFORNIA, CONNECTICUT, MASSACHUSETTS, NEW JERSEY, NEW YORK, PENNSYLVANIA, AND TEXAS.

About the author: Douglas Hedley