Market Observer - September 2023


John Finley, CFA

Chief Investment Officer

All investors watch the market to some degree or another. Short-term traders, for example, must keep close tabs on their market bets as they seek to profit (or cut their losses) from whatever direction their trade is going. At the other end of the spectrum, some true longterm investors are content with checking their investment portfolios on a quarterly or even semi-annual basis. Other investors, however, feel the constant need to see how their portfolios are doing, even looking multiple times throughout the day. Let’s call these investors perpetual market watchers.

They’re an interesting group: when stocks are down, especially during bear markets, they wonder if stocks will ever rise again. They have forgotten that the market fully recovered from every other bear market they had experienced. They question why they had so much in equities, second-guessing their asset-allocation among stocks, bonds, and cash. They fixate on any unrealized losses in their portfolio. Intellectually, they may say they are longterm investors, but secretly wonder if capitalism still works.

Some investors, ironically, can also feel uncomfortable during periods when stocks are up, especially near all-time market highs. Here is a chart of the S&P 500 Index so far this year:

Even with the market up over 17%, they question the sustainability of stock valuations, often nursing a nagging suspicion that a market collapse is lurking around the corner.

The underlying malady for both groups is chronic worry. For these investors, the 24/7 digital information landscape is constantly presenting them with things to be anxious about. No amount of historical market data will dissuade them from thinking that this time it really is different; that truly, one of those worrying headlines will finally come to pass, as they feared all along.

Even if you are an experienced, long-term investor, it is all too easy to slip into market-watcher mode, allowing the latest headlines from the financial media to consume your mind and feed the growing angst in your psyche. The biggest problem with persistent market watching is that the fear it creates can lead to sub-optimal investment decisions, such as selling when the market is down and then failing to reinvest as the market recovers.

The best antidote to such fear-infused investing is carefully observing what markets are doing in light of the historical record of capital market returns. For instance, as long as there have been markets, there has been asset price volatility. Not only is volatility the “cost of admission”to the capital markets, it is your daily, constant companion on the investment journey. It is inescapable. Experienced long-term investors are not surprised by a down market, or the increased volatility that comes with it.

In the U.S., since 1980 there has never been a calendar year without a stock market decline, as shown below with red dots: [3] The average intra-year drop in the S&P 500 Index was-14.3% during the 43-year period, which included four severe bear markets. Given that information, would you have guessed that the end-of-year calendar returns were positive in32 of those 43 years?

History also shows that stock market volatility also has a seasonal pattern. A widely recognized measure of equity volatility is the VIX Index, which estimates 30-day expected stock market volatility, and is derived from call and put options on the S&P 500 Index.

When the VIX volatility index rises, stocks tend to fall (and vice versa). Here is a chart showing the VIX Index so far this year (blue line) overlaid against its historical seasonal trend back to 1990 (purple line). If history is a guide, we may see stocks decline in September and October (but don’t bet on it).

Steep downturns in the market can be emotionally unsettling, even for experienced investors. But market history has shown us that U.S. stocks have tended to deliver positive returns over one-, three-, and five-years periods following steep market declines, as shown below:

Another way to think about market returns is to examine the historical record over different time segments. This table presents returns on the S&P 500 over one- to five-year rolling time periods since 1926:

Because we generally advise clients to invest in stocks only when those funds are not needed for five years or more, the five-year rolling returns are most relevant for our purposes here. 88% of the rolling five-year periods since 1926 were positive, with an arithmetic average return of 72%.

What does market history say to those investors who worry when markets get “too high”? Data since 1926 shows that 30% of all months ended at a market level above all previous levels(1,163 observation months). Here is an encouraging chart which compares those record high months to all the other months in terms of annualized compound returns.[1] You can see that there is practically no difference in five-year annualized returns between months that ended at a record high versus all other months, both coming in at just over 10% per year.

As an amateur wildlife photographer, I learned over time the necessity of honing my observational and listening skills if I ever hoped to capture sharp, well-composed images, especially of birds. Long before took up birding as a hobby, I would see birds, of course, but I seldom knew what species they were, much less anything about their behavior, habitats or migration patterns. Learning these things has improved my bird photography enormously. You become a student of bird behavior.

The application to investing is straightforward: we become better investors when we move beyond daily visceral reactions to what we see the market doing, to becoming a student of the capital markets. We should seek to be evidenced-based in our investing approach.

This is not to say that we always know why the market is doing what it is doing at any given moment of time: Markets behave (or misbehave) the way they do without necessarily providing us with rational reasons. Much of the daily or weekly volatility we see is not necessarily a signal of a specific underlying cause, but rather just noise, often driven by emotional trading activity.

Keeping market history front-of-mind helps us to overcome these short-term emotion-driven thoughts and behavior, which will lead to better long-term outcomes. In the end, when it comes to investing, it is about doing only those things that will help you to achieve your longterm financial goals, while resisting the pull of your emotions.

For some investors, taking up a new hobby could help. I highly recommend bird watching. It gets you outdoors to enjoy the therapeutic benefits of being in nature. It also beats market watching by a long shot.

John Finley, CFA

Chief Investment Officer

John Finley, CFA, is the Chief Investment Officer at Coyle Financial Counsel, where he leads the investment process. With over 20 years of experience managing institutional fixed-income portfolios for global corporations, pension funds, and non-profit organizations, he is dedicated to helping individuals achieve their long-term financial goals through investing.

All information is from sources deemed reliable, but no warranty is made to its accuracy or completeness. This material is being provided for informational or educational purposes only, and does not take into account the investment objectives or financial situation of any client or prospective client. The information is not intended as investment advice, and is not a recommendation to buy, sell, or invest in any particular investment or market segment. Those seeking information regarding their particular investment needs should contact a financial professional. Coyle, our employees, or our clients, may or may not be invested in any individual securities or market segments discussed in this material. The opinions expressed were current as of the date of posting but are subject to change without notice due to market, political, or economic conditions. All investments involve risk, including loss of principal. Past performance is not a guarantee of future results.

Copyright © 2023 Coyle Financial Counsel. All rights reserved.

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