Some days it just doesn’t seem that getting out of bed was worth it. You know — those days when the entire computer screen for your portfolio shows all red numbers. On those days, the tickers are changing so fast and the volumes are so high that it just makes your stomach turn.
We’ve seen a few days like that recently and decided to see how often it happens by examining the price action of SPY, EFA, EEM, VNQ and AGG over the 3 years ending January 15, 2008. They represent some, but not all, of the key asset classes found in many portfolios.
(NYSEARCA:SPY) = United States large cap stocks (S&P 500)
(NYSEARCA:EFA) = Foreign developed market stocks (MSCI EAFE)
(NYSEARCA:EEM) = Foreign emerging market stocks (MSCI Emerging)
(NYSEARCA:VNQ) = United States equity REITS (MSCI Equity REIT index)
(NYSEARCA:AGG) = United States total bond market (Lehman Aggregate Bonds).
There were 755 market days in that three year period. The S&P 500 rose in 415 of those days (55%), fell in 336 (44.5%), and was unchanged in 4 (0.5%).
It’s almost a coin toss whether the S&P 500 rises or falls on any given day, but the market does grant more up days than down. The average up day was +0.54% and the average down day -0.61%. Even though the average down day is more down that the average up day is up, the preponderance of up days squeaked out an average day over the three years going up 0.03%.
But what about those ALL RED days? How did owning foreign stocks help balance out owning domestic stocks? Did owning equity real estate trusts help? Did bonds make it better?
Of the 336 down days for SPY, 227 (67.5%) of them also saw both foreign developed markets EFA and foreign emerging markets EEM fall too.
Those markets, however, have clearly outperformed the U.S. market over three years and have been more volatile, but day-to-day their color on the screen looks sympathetic to SPY. The 3-year annualized returns are: SPY = 8.51%, EFA = 16.60% and EEM = 33%.
Side-stepping the statistical measure of volatility (standard deviation of return) — we love it, but most people turn glassy-eyed at its mention — the following chart of the daily price change of each of those funds shows the differences in volatility ("bounciness" of the price).
When we add domestic equity REITS (VNQ), only 174 (51.8%) of the 336 SPY down days saw all three of other funds (EFA, EEM and VNQ) go down too. On 274 days (81.5%), either two or all three of those funds declined when SPY declined.
If AGG (U.S. bonds) is added, 70 (20.8%) of the 336 down days for SPY saw all four other funds (EFA, EEM, VNQ and AGG) go down in sympathy. Those were really dark days. When your bonds and your stocks decline together, you can feel a bit helpless.
We think those very dark days tend to be shock days when everybody just wants to find an exit from the game and to hold short-term Treasuries or cash. Those might be days where geopolitical risk mushrooms, or oil prices skyrocket, or major financial system crisis news dominates.
On a positive note, there were 19 (5.7%) of the 336 SPY down days when all three of EFA, EEM and VNQ rose while SPY fell. That’s a small consolation. Day-to-day those markets are directionally more sympathetic with the U.S. stock market than not.
Just as when the S&P 500 has companions on the way down, it tends to have companions on the way up.
On the 415 SPY up days, 239 (57.5%) saw all four other classes (foreign developed and emerging markets, domestic equity real estate and domestic bonds)- rise at the same time.
Looking at U.S. bonds and U.S. stocks alone, we saw bonds go in the opposite direction of U.S. stocks 53.9% of the time — once again somewhat of a coin toss as to same or opposite direction. However, bonds don’t move as much as stocks and tend to provide risk and volatility reduction in difficult times, as the chart below demonstrates.
[click image to enlarge]
Even though the asset classes we are reviewing have a strong tendency to move in the same direction day-by-day, they do not move to the same degree (they have different volatilities), and as a result produce substantially different cumulative results, as the 3-year price chart below shows.
[click image to enlarge]
The take away message is, “don’t sweat the day-to-day … diversify asset classes and watch the intermediate to long-term”.
Pay attention to fundamental value. Allocate among multiple asset classes. Diversify well within each class. Rebalance to keep volatility risk consistent with your plan. Harvest profits. Don’t take more risk than is comfortable.
Read a bit each week to stay abreast. Stay calm. Seek advice when you are unsure. Don’t overpay for investment advice and demand regular and clear communication. Your advisor can help you maintain perspective and keep your eye on the long ball.
Expect the occasional all red days — stuff happens in the markets.