Looking back, 2018 certainly felt like a roller coaster ride for investors. After a fantastic nine year run where US stocks returned an annualized 15.44%, you can see why 2018’s results came as a surprise for many. Coming off their 4th best year since 2000, domestic stocks, as measured by the Russell 3000, had their first calendar year decline since 2008. The volatility in the equity markets seemed unusual given recent data, but in many ways 2018 provided a return to historical normalcy that we hadn’t seen yet this decade.
Up and Down Months
In many cases, 2018 proved to be the antithesis of 2017. Whereas 2017 had zero months with negative returns for US stocks, 2018 experienced 4 such months. In the 9 years leading up to 2018, US stocks were averaging 3.3 months with negative returns a year. Historically, US stocks have experienced 4.2 months with negative returns in any given year.
Distribution of Returns
Whereas 2018 had two months where stocks fell between 6% and 10%, 2017 had zero and up until the beginning of the year, there had only been five such months since the beginning of 2009 where stocks had declined that amount. Historically, those types of monthly declines occur about once every 21 months meaning that 2018 was less of an historical outlier than the nine years leading up to it.
A measure of historical volatility, the standard deviation of US stocks in 2018 was 15.5%. That stands in contrast with 2017 where standard deviation was a remarkably low 3.85%. Put simply, monthly returns for US stocks in 2017 didn’t deviate very much from the average return of 1.6%. Over the nine years leading up to 2018, standard deviation was 13.79%, lower than its historical average of 15.11%. Again, 2017 and the nine years before 2018 proved to be further from the norm than 2018 in terms of volatility.
The Balanced Investor
The best hedge investors have against stocks is high quality fixed income. US stocks declined 9.31% in December whereas high quality fixed income, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index, gained 1.84% during that time. Taking a historical view, the average annual decline for down years in the US stock market is -13.2%. The average annual return for the Aggregate Bond Index during those years is 7.25%.
What’s in Favor?
International stocks lagged their domestic counterparts over 2018, declining 14% over the year, after outperforming US stocks by 6.5% in 2017. What is in favor will come and go but including exposure to international equity has reduced portfolio volatility historically*.
While it certainly felt like a rocky year for US equity, viewing 2018 in a historical frame provides important context to the long-term investor. Going forward, we fully expect equity volatility to continue to remain “normal” as it was in 2018. The best way to capitalize is to remain disciplined to your investment plan and avoid letting emotion drive decisions.
Annualized standard deviation of the S&P 500 Index 01/1970 – 12/2018: 15.07%. Annualized standard deviation of 65% S&P 500 Index, 35% MSCI EAFE Index (net div.) 01/1970 – 12/2018: 14.25%.