The following memo was sent on Monday evening, February 5th at the start of this week's market action and volatility to BCM's current clients.
For those of you that have been following our blog, we have mentioned several times over the past few weeks how the stock market’s volatility has been extraordinary low. We’ve talked about how the volatility index (VIX) spent much of 2017 at less than half of its historical average. 2017 was the first year ever where all 12 months had positive returns. We shared how this bull market, the second-longest in history, has had the longest period without a 3% pullback since at least the Second World War. In 2017, the largest pullback was just 2.7%.
In addition, the markets have grown so vigorously for almost 9 years now that the scale ordinary market declines needs to be readjusted. For instance, back on February 5th, 2008, when the Dow Jones Industrial Average opened at 12,265, it meant that a 2.5% decline would equate to just over a 300 point decline. However, in January 2018 the DJIA peaked at ~26,600, which means that a 2.5% drop equates to 665 Dow points. The drop sounds scarier than it is due to the growth of all of the US stock indexes themselves.
We want to remind everyone that it is normal for the stock markets to pull back 5-10%. These normal or ordinary movements actually help sustain longer market cycles. Since the Second World War, the markets have averaged almost three ordinary pullbacks a year.
Reacting to 5-10% pullbacks often leads to whipsaw…the phenomena where the manager, expecting a large decline, sells only to find the market turn around and resume its ascent. The BCM strategies are not designed to react to these smaller pullbacks and, due to whipsaw, you don’t want them to. BCM’s growth strategies are meant to participate robustly in bull or sideways markets and start to get defensive only when necessary. To us, “necessary” tends to start after 10% but before the loss becomes too damaging.
If you invest in stocks, one should typically expect 5-10% pullbacks as a matter of course. No, they are not fun to endure, but they are common and your expectations need to be set accordingly. If a 10% drawdown is beyond your comfort zone, please speak to your BCM relationship manager as your current portfolio may not be the most appropriate for you.
Of course, no one knows where the markets will end up this week, this month, this quarter or even this year. Our rules-based systems are designed to remove emotion from the investment process. When volatility suddenly emerges as it has this month, we do not react emotionally but rather follow the rules. As of the close on Friday, the major US stock indices had yet to drop even 5% from their all-time highs. Today saw some extreme volatility including a 1,175 point drop on the DJIA. If we combine today’s ~4% drop with last week’s fall, we are still only barely negative for the year and the total drawdown of the markets is ~8%. Clearly volatility has returned to “normal”. Please know we stand ready to act if and when our systems warrant such a move but we will not try to anticipate nor will we panic.
For your reference, we have a position paper on the types, length and severity of the market pullbacks or worse.
Sincerely,
David M. Haviland I Managing Partner & Portfolio Manager
salessupport@investBCM.com I Phone 888.777.0535
