Some Thoughts on 2018

As we thought might happen, 2017 turned out to be a better year for the stock market than investors expected. The S&P 500®’s total return so far this year (through 11/30) is nearly 21%. Despite the consensus view that investors are confronting a “low return environment”, the S&P 500® has returned more than 15%/year over the last five years. Bonds (approximately 2%/year) and hedge funds (approximately 4%/year) certainly provided low returns, but the general perception that returns are below normal seems to reflect investors’ poor asset allocation decisions rather than the reality of public equity returns (see Chart 1).

CHART 1
Stocks vs. Bonds and Hedge Funds Past 5 years
(11/30/12 – 11/30/17)


Source: Richard Bernstein Advisors LLC., Bloomberg Finance L.P.

Investors still do not fully appreciate the magnitude of opportunity cost they have paid to alleviate their fears that 2008 would repeat. Considering the S&P 500® fell about 55% during 2008’s bear market, it seems rather irrational to be so scared as to sacrifice roughly 97% return (i.e., the 5-year compounded difference between stock and bond returns).

Chart 2 shows the historical probability of large drawdowns in the S&P 500®. Drawdowns similar to 2008’s have historically occurred only 0.5% of the time! Yet, both individual and institutional investors have been structuring portfolios as though the markets were necessarily going to replay 2008.

CHART 2:
S&P 500®: Historical Probability of a Loss
(Rolling 12-Month Total Returns, Dec. 1926 - Nov. 2017)

Source: Richard Bernstein Advisors LLC., Morningstar(Ibbotson)

Drawdowns similar to 2008’s have historically occurred only 0.5% of the time! Yet, both individual and institutional investors have been structuring portfolios as though the markets were necessarily going to replay 2008.