As a follow up to our recent blog post, The Return of Volatility, I would like to present evidence that historically it is not unusual to experience negative returns in multiple asset classes simultaneously on the path to long term investment success.
The table below offers a perspective on the frequency of severe negative volatility experienced by the domestic large cap, domestic small cap, international developed markets, and emerging markets equity asset classes. These classes are represented by the S&P 500 Index, CRSP 6-10 Index, MSCI EAFE Index, and MSCI Emerging Markets Index, respectively.
In this analysis, a downturn is defined as a 7% or greater decline in monthly value.
Note that performance for the S&P 500 and CRSP 6-10 dates back to 1926, while MSCI EAFE and MSCI Emerging Markets index are more recent (1970 and 1988).
Referring to the first column, the domestic large cap asset class, as represented by the S&P 500 Index, lost 7% or more of its market value in 63 of 1,032 total months from January 1926 to December 2011. The losing months represent only 6.1% of the total.
In the months following each 7% decline, the S&P 500 Index experienced an average annualized return of 8.8% over the next year, 9.0% over three years, 9.9% over five years, and 8.5% over 10 years.
The percentage of months at or below the -7% threshold are greatest for the domestic small cap and emerging markets asset groups, which reflects higher risk.
The data offer several important lessons:
- Although extreme negative performance, as defined by the -7% threshold, is not unusual for any of these asset classes, neither is it commonplace over this time period.
- On an average annualized basis, the asset classes logged positive performance in the one, three, five, and ten-year periods that began in the month following the -7% or lower return.
Investors who remained disciplined during market shocks were rewarded over the long term. Keep this in mind as you evaluate your choices in today’s investment environment.